Significance of Risk Modeling in the Term Structure of Interest Rates, Applied Financial Economics, 17(3): 237-247 (JEL Listed) (2007, in common with S. Papadamou)

Significance of Risk Modeling in the Term Structure of Interest Rates, Applied Financial Economics, 17(3): 237-247 (SCOPUS, EconLit Listed). In common with S. Papadamou (2007).

This paper examined the significance of risk modeling and asymmetries when researchers test the popular economic theories concerning the term structure of interest rates. A panel data set of returns on government bond portfolios was used and methods to account for related movements in risk premia across assets with different currency denomination were employed. Rather than attempting to model risk directly in terms of observables, we have instead exploited an implication of the CAPM concerning how risk premia for a given maturity structure would vary through time in a related manner across different type of assets. In light of recent non-linear research in the area of term structure of interest rates we investigated the hypothesis that the spread effect might has a non-linear impact on excess holding period yield (EHPY). Non-linear effects of spread on EHPY were found in all the maturity structure exception being the short-term maturities. There was evidence for a mean reversion process of returns only for large spread effects in international bond markets. Concerning the rational expectation hypothesis our empirical work provide evidence against it. However, testing this hypothesis over the longer maturity bonds can be very sensitive to the modeling process of risk and possible asymmetries.

JEL Classification: E43; C23; C52