Interest rate term premia and purchasing power parity deviations: the missing link?

Abstract

This paper analyses the various hypotheses regarding the term structure of interest rates. We test the expectations hypothesis for four major countries, namely, the United States, the United Kingdom, Germany and Japan. The data rejects the expectations hypothesis and the results indicate the presence of a time varying term premium. To explain the results, we posit a relationship between the changes in the term premium and changes in the PPP real exchange rates. The empirical results lend support to this relationship.