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E
Expectations Hypothesis
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An hypothesis about the relationship between interest rates and term to maturity which holds that the current term structure of interest rates is determined by the consensus forecast of future interest rates. Suppose that the spot interest rate for a one year instrument is 6 percent and the spot interest rate for a two year instrument is 7 percent. According to the expectations hypothesis, this term structure arises from the fact that investors believe a one year instrument one year in the future will yield 8.01 percent, because an investor could achieve the same return by investing in a one year instrument today and a one year instrument one year from now as could be achieved by investing in a two year instrument today. Based on the expectations hypothesis, an upward sloping yield curve implies that investors expect interest rates to rise. A flat yield curve implies that investors expect interest rates to remain unchanged. A downward sloping yield curve indicates that investors expect rates to fall. See also Yield Curve (diagrams).
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Glossary *
E
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