Template-type: ReDIF-Paper 1.0
Author-Name: Clive G. Bowsher
Author-Email: clive.bowsher@economics.ox.ac.uk
Author-Workplace-Name: Nuffield College, University of Oxford
Author-Workplace-Homepage: http://www.nuffield.ox.ac.uk/economics/
Author-Name: Roland Meeks
Author-Email: roland.meeks@economics.ox.ac.uk.ox.ac.uk
Author-Workplace-Name: Nuffield College, University of Oxford
Author-Workplace-Homepage: http://www.nuffield.ox.ac.uk/economics/
Title: The Impossibility of Stationary Yield Spreads and I(1) Yields under the
Expectations Theory of the Term Structure
Abstract: It is a widely encountered misconception that the vector of spreads between 
longer-term interest rates and the short rate is stationary under the 
Expectations Theory (ET). By considering a complete term structure of maturities 
it is shown that the ET determines the conditional mean of the VAR process followed 
by the yield curve. We prove that under this process, the zero-coupon yield curve is 
I(2), immediately casting doubt on the empirical usefulness of the ET. Furthermore,
the yield spreads are shown to be a non-stationary, cointegrated I(1) process. This 
result invalidates many existing approaches to evaluating and formally testing the ET.
Finally, time series features of yield curve data simulated under the ET are compared 
with those of actual US Treasury zero-coupon yield curves.
Keywords: Expectations theory, term structure, yield curve, I(2) process, I(1) process,
cointegration.
Classification-JEL: C32, C33, G12.
Length: 17 pages
Creation-Date: 2006-06-08
Number: 2006-W05
Handle: RePEc:nuf:econwp:0605