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RFS Advance Access originally published online on January 20, 2006
Review of Financial Studies 2006 19(2):359-379; doi:10.1093/rfs/hhj019
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org.

The Behavior of Interest Rates

Eugene F. Fama
University of Chicago

Address correspondence to Graduate School of Business, University of Chicago, 5807 S. Woodlawn Avenue, Chicago, IL 60637, or email: eugene.fama{at}gsb.uchicago.edu

The evidence in Fama and Bliss (1987) that forward interest rates forecast future spot interest rates for horizons beyond a year repeats in the out-of-sample 1986–2004 period. But the inference that this forecast power is due to mean reversion of the spot rate toward a constant expected value no longer seems valid. Instead, the predictability of the spot rate captured by forward rates seems to be due to mean reversion toward a time-varying expected value that is subject to a sequence of apparently permanent shocks that are on balance positive to mid-1981 and on balance negative thereafter.


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