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July/August 1992, 
Vol. 74, No. 4
Posted 1992-06-01

Understanding the Term Structure of Interest Rates: The Expectations Theory

by Steven H. Russell

Steven Russell describes the most popular theory of the term structure, the expectations theory. After laying out the building blocks of the expectations theory, Russell shows how the expectations of participants in financial markets and the decisions they make create linkages between the market interest rates on short- and long-term securities. Finally, Russell shows how the expectations theory can be used to explain two important empirical features of the interest rate term structure.