Variable risk and the term structure

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Virginia Polytechnic Institute and State University


The variable risk hypothesis states that if individuals do perceive a change in risk, and if this change is taken into account in their decision-making process, then it seems plausible to include some measure of risk as a variable in empirical studies where risk is a factor. Some reasonable measures of risk are proposed based on the concept of a moving information set where the information used to evaluate risk is changing.over time. The resulting measure of risk is the moving coefficient of variation. The variable risk hypothesis is then applied to the term structure of interest rates. The empirical testing generates further support for the liquidity and term premium hypotheses, while a test of the segmented markets hypothesis using this measure of risk is not supportive.