Domestic variance and international comovement bonds tests of interest rates

Document Type

Article

Publication Date

3-1999

Publication Title

International Review of Financial Analysis

Abstract

This article demonstrates that long rates exhibit both domestic excess variance and international excess comovement compared to fundamental yields derived from short rates under the rational expectations theory of term structure. The results are consistent for all countries sampled: the US, UK, Canada, Germany, and Japan. Probing deeper, long rates are found to “overreact” to domestic expected future inflation and/or short real rates both of which are the underlying components of the short nominal rate according to the Fisher hypothesis. Since inflation rates as well as short real rates are highly correlated between countries, the excess volatility in long rates translates into excess covariance (“co-overreact”) internationally.

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Copyright © 2000 Elsevier Science Inc. All rights reserved.

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