Yield Factors, the Expectations Hypothesis and Regime Shifts

This paper reexamines the expectations hypothesis of interest rates using US monthly data for bond yields ranging in maturity from 1 month to 10 years. We extend the Campbell-Shiller (1987) method to increase the test power: (a) by introducing economic variables as conditioning information; and (b) by explicitly taking regime shifts into consideration. We apply the new method to Treasury bond yields and find that the expectations hypothesis is rarely rejected by the US term structure data. We also find that two regimes are related to the business cycle and monetary policy.