7 Let hy6; be the three-month holding yield from buying a six-month U.S. Treasury bill at...

 

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7 Let hy6; be the three-month holding yield from buying a six-month U.S. Treasury bill at time t-1 and selling it at time t as a three-month Treasury bill. Further, let hy3t be the three-month holding yield from buying a three-month Treasury bill at time t-1. The expectation hypothesis implies that the slope coefficient in the regression of hy6, on hy3, should not be statistically different from one. (a) Assuming that there is evidence of a unit root in hy3t, discuss prob- lems with standard OLS analysis of the above regression. (b) Rewrite the following model in the error correction form hy6t=00+01hy61-1 + 0hy3t+03hy31-1 + ut. (3) What constraint on the parameters 01,...,03 is implied by the expec- tation hypothesis? (c) Assuming that the constraint holds, explain how you would estimate the error correction form of equation (3). How would you test for serial correlation in u? 7 Let hy6; be the three-month holding yield from buying a six-month U.S. Treasury bill at time t-1 and selling it at time t as a three-month Treasury bill. Further, let hy3t be the three-month holding yield from buying a three-month Treasury bill at time t-1. The expectation hypothesis implies that the slope coefficient in the regression of hy6, on hy3, should not be statistically different from one. (a) Assuming that there is evidence of a unit root in hy3t, discuss prob- lems with standard OLS analysis of the above regression. (b) Rewrite the following model in the error correction form hy6t=00+01hy61-1 + 0hy3t+03hy31-1 + ut. (3) What constraint on the parameters 01,...,03 is implied by the expec- tation hypothesis? (c) Assuming that the constraint holds, explain how you would estimate the error correction form of equation (3). How would you test for serial correlation in u?

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a When there is evidence of a unit root in hy3t it indicates a nonstationary time series In such cas... View the full answer