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If you are familiar with the "Pure Expectations Theory" on the term structure of interest rates, you probably know why it is generally dismissed. Apparently it neglects the risks inherent in investing in bonds (because forward rates are not perfect predictors of future rates).

But I do not get this point of critique. Why does the theory have anything to do with the risks inherent in investing in bonds? Why does the fact that we do not know the future value of long-term bonds contradict the essence of the expectations theory, namely that the term structure of interest rates is a snapshot of the markets expectations about future interest rates?

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migrated from Mar 22 '15 at 19:47

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