The Expectations Hypothesis of the Term Structure: Further Empirical Evidence for India (1996-2013)

This paper extends the analysis of Tronzano (2015) inside a multivariate cointegration framework. I show that the Indian term structure of interest rates is driven by one common stochastic trend. Moreover, closely in line with Tronzano (2015), I document that the “symmetry” condition on cointegrating vectors is supported by data, whereas the “Pure” version of the Expectations Hypothesis is strongly rejected. Further investigation through variance decomposition tests and persistency profiles of cointegrating vectors corroborates other results obtained in Tronzano (2015) (i.e. short-term interest rate exogeneity and a faster adjustment speed of spreads at shorter maturities). Overall, these results provide strong empirical support for a monetary policy strategy relying on a short-term interest rate target.