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Uncertainty and implied variance bounds in long-memory models of the interest rate term structure

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Summary

We find that long-term uncertainty in a linear model of the interest rate term structure can have dramatic effects on variance bounds implied by the expectations theories of the term structure. We bootstrap fractionally integrated models of the term structure of interest rates. The fractional order of integration's bootstrapped standard errors simulate uncertainty surrounding long-term forecasts of interest rates, and we find that it is possible to overstate the significance of variance-bounds violations by at least a factor of three and perhaps by a factor of ten when long-term uncertainty is ignored.

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Authors and Affiliations

  1. The Pennsylvania State University, 609 Business Administration Building, 16802, University Park, Pennsylvania

    G. S. Shea

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  1. G. S. Shea
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Additional information

I wish to thank Frank Diebold, Baldey Raj, Eric Renault, Fallaw Sowell and several anonymous referees for their comments and suggestions for earlier versions of this paper. The paper also benefited from comments made by many seminar participants at the World Econometric Congress, the European Econometric Society, and the American Finance Association meetings, the Board of Governors of the Federal Reserve System, the Ecole Nationale de la Statistique et de l'Administration Economique, and the departments of Finance and Statistics at Penn State University.

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Shea, G.S. Uncertainty and implied variance bounds in long-memory models of the interest rate term structure. Empirical Economics 16, 287–312 (1991). https://doi.org/10.1007/BF01206277

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  • DOI: https://doi.org/10.1007/BF01206277

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