Mean-Variance Cointegration and the Expectations Hypothesis

Abstract

The present paper sheds further light on a well-known (alleged) violation of the expec- tations hypothesis of the term structure (EHT) - the frequent finding of unit roots in interest rate spreads. We show that the EHT implies (i) that the nonstationarity stems from the holding premium, which is hence (ii) cointegrated with the spread. In a stochas- tic discount factor framework we model the premium as being driven by the integrated variance of excess returns. Introducing the concept of mean-variance cointegration we actually find cointegration relations between spreads and premia in US data.