Can someone help me with the difference between broadest interpretation form and local interpretation form. I don’t know why the book is saying the same thing to me with different words.
from my notes: i. Broad interpretation: can be interpreted as ‘whether you buy a 1 year bond, or a 10 year bond and sell it in a year, you’ll get the same return’. The error in this assumption is that selling the 10 year bond exposes you to price risk for that 10 year bond (if interest rates rise, you won’t get as much for it come sell time) ii. Local expectations interpretation: this one takes into account that price risk exists, but recognizes that if everything goes the way things are planned (with respect to forward rates) then it shouldn’t matter what maturity you sign up for in your investment purchase, you will realize the same yield. so the difference I see is that in local expectations theory, you acknowledge price risk, but in the broad interpretation, you don’t.
I think of broad interpretation as the expectation theory holding in the long term and the expected returns being the same for any maturity and the local being the same but only holding in the short term. Broad doesn’t hold and local does.
thank you for the help
so, who is correct? Magicskyfairy or LincolnLogs?? Magicskyfairy says that the difference is that broad interpretation does not recognize price risk but local interpretation acknowledges it. Lincoln logs says that broad interpretation is for long term and local interpretation is for short term. My understanding was the same as that of LincolnLogs. Any body ready to break the tie between the two and explain his / her stand??? HELP!!!
this stuff is in level II? I must have missed it big time. shit
They both are correct as I read it! The broad form does not consider price risk (interest risk or reinvestment risk), and assumes indifference to investments of the same holding period. The local form acknowledges price risk, and says expectation theory holds as long as the investment time frame is short. Magics was right about long is fine if expectation hold for long-term (but this is rarely true). Lincoln should probably have said broad for is for short and long-term, and local holds only over short-term, to be more specific.
hooray! everybody wins!