This paper utilizes a Markov-switching framework to model excess returns in federal funds futures contracts. This framework identifies a high-volatility state where excess returns are large, positive, and volatile and a low-volatility state where excess returns have a lower volatility and are small in absolute value. Federal funds futures rates require adjustment for excess returns only in the high-volatility state. Intermeeting rate cuts of the federal funds rate target always correspond with the high-volatility regime and can explain much of the variation in excess returns. This paper also examines previous return models and helps clarify the relationship between excess returns, business cycles, and intermeeting rate cuts. In real-time forecasting, however, the unadjusted futures rates outperform three different forecasting models. This result strengthens the case for unadjusted futures rates as a measure of monetary policy expectations.
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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number
RWP 07-08.
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Hakkio, Craig S, 1981.
"Expectations and the Forward Exchange Rate,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 22(3), pages 663-78, October.
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