On the Long-Run Stability of Term Premia

Basma Bekdache and Byeongseon Seo - Wayne State University

This paper investigates the long-run behavior of term premia using holding returns in bonds with maturities ranging from one-month to 10 years. Of particular interest is whether the one-period holding return on any k-period bond (H_{t+1}^k) and the yield on a one period security (R_t) are cointegrated, with the excess return (H_{t+1}^k - R_t) defining the cointegration vector. A finding of such a cointegrating relationship implies that excess returns or term premia in bonds are stationary, as predicted by the expectations hypothesis (EH) of the term structure of interest rates.

Previous studies document instability in the long-run relationship between yields of different maturities. Hall, Anderson and Granger (1992) (HAG) investigate an analogous implication of EH that yields on bonds of different maturities are cointegrated with the spreads between yields forming the cointegration vectors. Using data on Treasury bill yields from one to twelve month to maturity, they find that the cointegrating relationship between yields changes during the period between October 1979 and September 1988. Using a longer data sample and longer term yields, Engsted and Tangaard (1994) find that the break in the cointegration relationship reported by HAG does not occur in the longer maturity term structure. In another recent study, Evans and Lewis (1994) test restrictions on the cointegrating relationship between forward rates and spot rates and conclude that excess returns in U.S. Treasury bills are non-stationary.

Given these results, we investigate the cointegration properties of a system of holding returns for the full maturity spectrum for the period from January 1952 to December 1991. We construct holding returns from the monthly term structure data set provided by McCulloch and Kwon (1993). Then, we test the stability of the long-run relationships of term premia using new tests developed by Seo (1996).

Scheduled for Session 6.1 Computation And Econometrics - III