Abstract:
Using five benchmark rates from the Indian Money Market, this paper tests the Expectation Hypothesis (EH) with constant term premium. The data analysis draws on Johansen’s test for multivariate cointegration and the corresponding Error Correction Models approach. The empirical results are in favor of the EH holding in the Indian money market. The five interest rates are found to be completely integrated and the spreads are able to predict changes in the short term rates. The acceptance of the validity of the EH in the Indian money market implies that this market is an efficient vehicle for monetary policy implementation. For the sample period we examined, the Indian money market accomplished its role as a means of formulating market expectations in accordance with those of monetary policy makers.
