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Let Pnt denote the log price of an n-period zero coupon bond at time t, Ynt the log yield-to-maturity of the bond, In,t+1 the one-period-holding-period
Let Pnt denote the log price of an n-period zero coupon bond at time t, Ynt the log yield-to-maturity of the bond, In,t+1 the one-period-holding-period log return of the bond, and fnt the forward rate for a one-period bond investment to be made at time t+n. a) State the mathematical formulation of the expectations hypothesis of the term-structure of interest rates using the notation above. Also state the formulation of the pure expectations hypothesis. Provide an intuitive description of what this hypothesis predicts about interest-rate movements. b) Describe how, using a simple linear regression, you could use the expression(s) you provide above to conduct tests of the expectations hypothesis. c) Do empirical tests of the expectations hypothesis of the term structure of interest rates confirm that it is correct? Discuss results obtained in tests that use both short-maturity bonds and long-maturity bonds
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