Revisiting the expectations hypothesis: The Japanese term structure and regime shifts

This paper re-examines the expectations hypothesis of the Japanese term structure along two dimensions: (a) allowing regime shifts in interest rate dynamics; (b) introducing macroeconomic factors as conditioning information. The empirical analysis suggests that the expectations hypothesis is an inadequate description of the Japanese term structure even after taking account of regime shifts. However, I find that regime shift is a salient feature of the Japanese term structure and regimes are intimately related to economic activities.

Research highlights▶ Regime shifts cannot account for the failure of the expectations hypothesis. ▶ Macro factors cannot account for the failure of the expectations hypothesis. ▶ Time-varying risk premiums are important in understanding yield dynamics. ▶ Regime shift is a salient feature of the Japanese term structure.