An empirical analysis of the term structure of interest rates in New Zealand during the post-1985 financial liberalization period is presented. Particular emphasis is placed upon the effect of time-varying risk premia in the term structure equation. The risk premium is assumed to depend on the time-varying conditional variance of the excess holding yield. The results indicate that the expectations theory cannot be rejected at the short end of the term structure provided that account is taken of the volatility clustering in interest rate data. There is also support for the expectations theory in the term structure relationship between long-term and short-term interest rates. The results do not indicate excess over- or under-sensitivity of long rates to current short rates. Initial statistical evidence suggests that excess returns on long-term bonds can be explained by their lagged values and macroeconomic variables. However, this return predictability is removed once the effects of changing real and nominal uncertainty are accounted for in the term structure equation. The latter result suggests that a monetary policy of low and stable inflation can affect the risk characteristics of long-term bonds. The presence of varying real uncertainty in bond returns indicates that the slope of the yield curve may not be a reliable indicator for assessing inflationary pressures in the economy when compared to a situation where the variation in bond returns was solely driven by nominal uncertainty.