Yield Spreads and Interest Rate Movements: A Bird's Eye View

42 Pages Posted: 27 Apr 2000 Last revised: 13 Feb 2022

See all articles by John Y. Campbell

John Y. Campbell

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Robert J. Shiller

Yale University - Cowles Foundation; National Bureau of Economic Research (NBER); Yale University - International Center for Finance

Date Written: October 1989

Abstract

The expectations theory of the term structure implies that the spread between a longer-term interest rate and a shorter-term interest rate forecasts two subsequent interest rate changes: the change in yield of the longer-term bond over the life of the shorter-term bond, and a weighted average of the changes in shorter-term rates over the life of the longer-term bond. For postwar U.S. data from Mcculloch [1987] and just about any combination of maturities between one month and ten years we find that the former relation is not borne out by the data, the latter roughly is. When the yield spread is high the yield on the longer-term bond tends to fall, contrary to the expectations theory; at the same time, the shorter-term interest rate tends to rise, just as the expectations theory requires. We discuss several possible interpretations of these findings. We argue that they are consistent with a model in which the spread is a multiple of the value implied by the expectations theory. This model could be generated by time-varying risk premia which are correlated with expected increases in short-term interest rates, or by a failure of rational expectations in our sample period.

Suggested Citation

Campbell, John Y. and Shiller, Robert J., Yield Spreads and Interest Rate Movements: A Bird's Eye View (October 1989). NBER Working Paper No. w3153, Available at SSRN: https://ssrn.com/abstract=227301

John Y. Campbell (Contact Author)

Harvard University - Department of Economics ( email )

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Robert J. Shiller

Yale University - Cowles Foundation ( email )

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HOME PAGE: http://www.econ.yale.edu/~shiller/

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Yale University - International Center for Finance ( email )

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United States
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203-432-6167 (Fax)

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