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Definition of Expectations hypothesis theories

Expectations Hypothesis Theories Image 1

Expectations hypothesis theories

theories of the term structure of interest rates which include the pure
expectations theory, the liquidity theory of the term structure, and the preferred habitat theory. These theories
hold that each forward rate equals the expected future interest rate for the relevant period. These three theories
differ, however, on whether other factors also affect forward rates, and how.
expectations theory of forward exchange rates A theory of foreign exchange rates that holds that the
expected future spot foreign exchange rate t periods in the future equals the current t-period forward exchange
rate.



Related Terms:

Accelerationist Hypothesis

Belief that an effort to keep unemployment below its natural rate results in an accelerating inflation.


Biased expectations theories

Related: pure expectations theory.


Efficient Market Hypothesis

In general the hypothesis states that all relevant information is fully and
immediately reflected in a security's market price thereby assuming that an investor will obtain an equilibrium
rate of return. In other words, an investor should not expect to earn an abnormal return (above the market
return) through either technical analysis or fundamental analysis. Three forms of efficient market hypothesis
exist: weak form (stock prices reflect all information of past prices), semi-strong form (stock prices reflect all
publicly available information) and strong form (stock prices reflect all relevant information including insider
information).


Efficient Markets Hypothesis

The hypothesis that securities are typically in equilibrium--that they are fairly priced in the sense that the price reflects all publicly available information on the security.


expectations theory of exchange rates

Theory that expected spot exchange rate equals the forward rate.



Homogenous expectations assumption

An assumption of Markowitz portfolio construction that investors
have the same expectations with respect to the inputs that are used to derive efficient portfolios: asset returns,
variances, and covariances.


Liquidity preference hypothesis

The argument that greater liquidity is valuable, all else equal. Also, the
theory that the forward rate exceeds expected future interest rates.


Expectations Hypothesis Theories Image 2

Local expectations theory

A form of the pure expectations theory which suggests that the returns on bonds
of different maturities will be the same over a short-term investment horizon.


Overreaction hypothesis

The supposition that investors overreact to unanticipated news, resulting in
exaggerated movement in stock prices followed by corrections.


Permanent Income Hypothesis

Theory that individuals base current consumption spending on their perceived long-run average income rather than their current income.


Pure expectations theory

A theory that asserts that the forward rates exclusively represent the expected
future rates. In other words, the entire term structure reflects the markets expectations of future short-term
rates. For example, an increasing sloping term structure implies increasing short-term interest rates. Related:
biased expectations theories


Rational expectations

The idea that people rationally anticipate the future and respond to what they see ahead.


Rational Expectations

The best forecasts that can be made given the data available and knowledge of how the economy operates. Rational expectations implies random errors, no systematic errors.


Return-to-maturity expectations

A variant of pure expectations theory which suggests that the return that an
investor will realize by rolling over short-term bonds to some investment horizon will be the same as holding
a zero-coupon bond with a maturity that is the same as that investment horizon.



 

 

 

 

 

 

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