Hi Tim, yep I think you are on the right track, brake fluid is hygroscopic- absorbs water, when the brake heats up the water is turned to vapour, a steam bubble, which is no use as the effort from the master cylinder is not transferred to the caliper. when the system cools the steam returns to liquid and the brake returns.

Its easy to replace the old fluid with new Dot 4. fit a hose to the caliper bleeder other end into a clear bottle etc, open [8mm iirc] now make sure you keep the resovoir topped up pump away until the old is flushed out. important- the last pump hold down the pedal and close the bleeder. pump a few times to make sure you have a firm pedal. and you are good to go.

bernard