pure expectations theory

CFA Level II Fixed Income
#1

On the pure expectations theory- I don’t get axactly why it implies the market expects short-term rates to rise? Doesn’t it just imply that investor’s are indifferent about investing for a full time frame vs rolling a 1 year securtiy into like a 2 year security- assuming the return will be the same? I don’t get why it also implies that short-term rates are expected to increase? Similary- am I right in assuming the pure expectations theory does NOT assume an upward sloping yield curve? I know the pure (or unbiased) expectations theory says forward rates directly represent future spots…is another way to put this that- ‘expectations theory says longer term rates are predictors of future short-term rates’?

Clearly I’m a bit confused…

#2

Pure expectations theory simply says that current forward rates are expected to become future spot rates.

So a normal yield curve implies expectations of future rates rising, while an inverted yield curve implies expectations of future rates falling.

#3

thanks!

#4

My pleasure.