The Information in the Term Structure German Interest Rates

Gianna Boero
University of Cagliari and CRENoS

Foruhar Madjlessi
University of Karlsruhe

Costanza Torricelli
University of Modena
Torricelli@unimo.it

Abstract

This paper investigates the informative content of the term structure for German interest rates Most of the empirical work on this subject has concentrated on tests of the Expectations Hypothesis by using US interest rate data, and the hypothesis has been found to be rejected in the great majority of cases. However, term structure information failures may simply be a reflection of the specific data used and of the particular framework within which the hypothesis has been tested. In fact, in most empirical work the information in the term structure is represented only by some measure of its slope, while an important element, that is a time-varying term premium, is missed from the specification of the models. This paper examines further the information content of the term structure using monthly data for Germany and, following the general equilibrium theory of the term premium, extends the standard framework of the EH by including a measure of the riskless rate volatility in the information set. Our results indicate that the German term structure appears to forecast future short term interest rates surprinsingly well, compared with previous studies with US data. Moreover, and in line with previous findings, the slope of the term structure alone does not have predictive power for long term interest rate movements, through the direction suggested by the coefficient estimates is correct. Finally, inclusion of a volatility term represents an improvement in most regressions for the short rate, and significantly improves those for the long rate.

Keywords: Information, interest rate, term structure, term premia, volatility.

JEL-Classification: C22, E43, G14.