The deregulation of the Japanese financial markets and the adoption of an interest rate policy instrument by the Bank of Japan prompted a number of empirical investigations of the expectations hypothesis (EH) of the term structures of interest rates in Japan. This paper is a continuation of this research. It deviates from the previous work on the EH in Japan in two respects. First, it tests the EH by estimating a general vector autoregression (VAR) of the long-term and short-term rates and testing the restrictions implied by the EH on the VAR using a Lagrange multiplier (LM) test. Second, the issue of stationarity of interest rates is considered. The paper not only considers the possibility that Japanese interest rates are nonstationary, but also analyzes the implications of nonstationarity for the EH.
Keywords: Expectations hypothesis; Nonstationarity; Vector autoregression; Lagrange multiplier test
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.