Testing the expectations hypothesis: some new evidence for Japan

The deregulation of the Japanese financial markets and the adoption of an interest rate policy instrument by the Bank of Japan prompted a number of empirical investigations of the expectation hypothesis (EH) of the term structures of interest rates in Japan. This paper is a continuation of this research. It deviates from the previous work on the EH in Japan in two respects. It tests the EH by estimating a general vector autoregression (VAR) of the long-term and short-term rates and testing the restrictions implied by the EH on the VAR using a Lagrange multiplier test. In addition, the issue of stationarity of interest rates is considered. The paper not only considers the possibility that Japanese interest rates are nonstationary, but analyzes the implications of non-stationarity for the EH.