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Duke Economics Working Paper #05-03

Expectations Hypotheses Tests and
Predictive Regressions at Long Horizons

Barbara Rossi†

February 2005

Abstract

Many rational expectations models state that an economic variable is determined as the present value of future variables. These restrictions have traditionally been tested on VARs where variables appear either in levels (or cointegrating relationships) or first differences. Commonly used test statistics may lead to over-rejections in small samples in the presence of highly persistent variables. Similar problems occur in longhorizon predictive regressions. We propose an alternative method based on local-tounity asymptotic approximations. We apply this method to long-horizon Predictive Regressions, Uncovered Interest Rate Parity, the Term Structure, and the Permanent Income Hypothesis.

JEL Classification Codes: F300; F400.

Keywords: expectation hypotheses; present value models; long-horizon; local to unity.

†Department of Economics, Duke University, Durham NC27708 USA.

E-mail: brossi@econ.duke.edu. Tel.: (919) 660 1801. Fax: (919) 684 8974.

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