The Expectations Hypothesis of the Term Structure: The UK Interbank Market

Abstract

Using a high quality weekly data set we provide several tests of the expectations hypothesis EH, using the VAR and cointegration methodologies, for several maturities between 1-week and 12-months, for the UK interbank market. On the basis of the Johansen cointegration analysis there appears to be a ‘break' in the term structure when both the six-month and twelve-month maturities are included as a pair. The latter may be due to either the presence of liquidity constraints or, market segmentation or, a time varying term premium, all of which would invalidate the assumptions underlying the EH. We provide some tentative explanations of these diverse results.