According to the Unbiased Expectations Theory

Question

BlackTom AI · Accepted Answer

The question asks about the Unbiased Expectations Theory. Since the provided data includes only one listed answer—'the long-term spot rate is an average of the current and expected future short-term interest rates'—we cannot analyze multiple options in comparison. Nevertheless, we can reason about this statement in light of the theory. Under the Unbiased Expectations Theory, the long-term interest rate is determined by the market’s expectations of future short-term rates, implying that the long-run rate equals the average (or expected path) of current and future short-term rates. This conceptualization means that today’s long-term rate reflects what market participants expect for future short-term rates, integrated over the horizon of the long-term loan, and it implies a kite-shaped relationship where the long-term rate is not systematically biased up or down by risk premia. If we consider the single provided option, it aligns with the core idea: the long-term spot rate represents an average (or expected path) of current and anticipated future short-term rates. Potential misconceptions in other, unseen options could include ideas such as long-term rates being determined solely by current rates, or that they incorporate risk premia independent of expectations, or that all horizons move independently. Those would conflict with the premise of the Unbiased Expectations Theory, which emphasizes that long-term rates are a reflection of expected short-term rates rather than independent premiums or static values. Since no alternative choices are given to evaluate, we cannot dissect them item-by-item, but the stated option coherently captures the central claim of the theory: long-term rates are anchored in the expected trajectory of future short-term rates, effectively an average (in expectation) of those rates over the term.

According to the Unbiased Expectations Theory

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