| Summary: | 碩士 === 東海大學 === 財務金融學系 === 101 === Past literature indicates that the rejection of expectation hypothesis of the term structure of interest rates is mainly attributable to time-varying term premium. This paper studies whether investor sentiment can explain the failure of expectation hypothesis. Following Froot (1989) to study not only the term premium, but also the expectation error. Consumer Confidence Index, a proxy of investor sentiment, is used to study whether it can be a factor explaining the failure of expectation hypothesis.
This paper uses London Interbank Offering Rate denominating in US dollar, British pound, Japanese yen, and Euro to test the hypothesis, and Forward Rate Agreement is chosen as the proxy of expected future rate, to compute expectation error. Then we study whether investor sentiment is an important determinant of expectation error. The results indicate that expectation hypothesis is overwhelmingly rejected, consistent with the findings of Froot (1989). We found that investor sentiment is positive relating to the expectation error for rates of Japanese yen, Euro and British pounds, reflecting that investors’ bullishness has an impact on expectation error. Overall results show that investor bullishness or bearishness is an important factor determining the failure of expectation hypothesis.
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