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Economic Quarterly

Winter 1995

The Rational Expectations Hypothesis of the Term Structure, Monetary Policy, and Time-Varying Term Premia

Michael Dotsey and Christopher Otrok

Most empirical studies of the rational expectations hypothesis of the term structure find that the data offer little support for the theory. This observation has led some investigators to search for alternative “irrational” theories of behavior in order to explain the data. The authors, on the other hand, find that a model that incorporates Federal Reserve behavior and a reasonable parameterization of term premia is consistent with empirical results.

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