This paper examines the validity of the Expectations Hypothesis of the term structure in India during the recent post-liberalization period. Overall, the empirical evidence provides substantial support for a cointegrating relationship across all assets maturities, and documents one-to-one co-movements between short and long-term interest rates. The “Pure” version of the Expectations Hypothesis, however, is strongly rejected due to the existence of significant risk premia components at all temporal horizons. VECM causality tests reveal that, in most cases, the short-term policy rate is strongly exogenous. This last result confirms the validity of the current monetary policy strategy relying on a short-term policy target, suggesting that it should mainly focus on the management of longer term assets maturities.
The Term Structure of Interest Rates in India: Evidence from the Post-Liberalization Period (1996-2013)
TRONZANO, MARCO ROBERTO
2015-01-01
Abstract
This paper examines the validity of the Expectations Hypothesis of the term structure in India during the recent post-liberalization period. Overall, the empirical evidence provides substantial support for a cointegrating relationship across all assets maturities, and documents one-to-one co-movements between short and long-term interest rates. The “Pure” version of the Expectations Hypothesis, however, is strongly rejected due to the existence of significant risk premia components at all temporal horizons. VECM causality tests reveal that, in most cases, the short-term policy rate is strongly exogenous. This last result confirms the validity of the current monetary policy strategy relying on a short-term policy target, suggesting that it should mainly focus on the management of longer term assets maturities.
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