The Expectations Hypothesis of the Term Structure of LIBOR US Dollar Interest Rates

Using the monthly sampled data on LIBOR US dollar interest rates and maturities ranging from 1 to 12 months from 1995 to 2009 we provide with a number of tests of the expectations hypothesis based on a 3-variable VAR allowing for a time-varying term premium. We find some evidence against the expectations hypothesis. The term premia appear to vary in time and the yield spread has a good predictive power, however the long rates under-react to current information about future short rates. Unexpected changes in holding period returns to large extent depend upon revisions to forecasts about future short rates and to small extent upon revisions to future term premia.