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Federal Funds Futures, Spot Rates, and Expected Changes in Monetary Policy

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  • Doug Rolph

    ()
    (University of Washington)

Abstract

Market participants, researchers and policy makers often use Federal funds futures as a proxy for the market's expectation of changes in monetary policy. This paper examines how well the Fed funds futures rate predicts changes in the Fed fund target rate relative to what the spot rate predicts. This approach differs from previous tests of information content of futures prices. Tests for the information content of futures prices often look at how well the futures prices predict the changes in spot prices. These tests may be thought of as incremental in the sense that they test the incremental benefit of adding more information (the futures price) to the null model. In the case of Fed funds futures, we may want to know whether futures or spot rates have more information about future changes in the Fed funds target rate. The paper identifies two separate models of expected changes in monetary policy. One model uses information embedded in the spot rate, while the other uses information embedded in the futures rate. The paper uses an encompassing regression framework to test the relative ability of the two models in predicting changes in the target rate. Results indicate that the relative information content of the futures rate has varied over time. During the period of initial futures market formation, the futures and spot rates have the same information. More recently, however, the futures rate seems to contain more information about future changes in monetary policy than the spot rate contains.

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 1999 with number 853.

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Date of creation: 01 Mar 1999
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Handle: RePEc:sce:scecf9:853

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  1. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
  2. Ben Bernanke, 1990. "The Federal Funds Rate and the Channels of Monetary Transnission," NBER Working Papers 3487, National Bureau of Economic Research, Inc.
  3. Hamilton, James D, 1996. "The Daily Market for Federal Funds," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 26-56, February.
  4. Russell Davidson & James G. MacKinnon, 1980. "Several Tests for Model Specification in the Presence of Alternative Hypotheses," Working Papers 378, Queen's University, Department of Economics.
  5. Davidson, Russell & MacKinnon, James G., 1993. "Estimation and Inference in Econometrics," OUP Catalogue, Oxford University Press, number 9780195060119, September.
  6. Kamara, A., 1988. "Trading Structures And Asset Pricing: Evidence From The Treasury Bill Markets," Papers 169, Columbia - Center for Futures Markets.
  7. Godfrey, L. G. & Pesaran, M. H., 1983. "Tests of non-nested regression models: Small sample adjustments and Monte Carlo evidence," Journal of Econometrics, Elsevier, vol. 21(1), pages 133-154, January.
  8. Campbell, John, 1987. "Money Announcements, The Demand for Bank Reserves, and the Behavior of the Federal Funds Rate within the Statement Week," Scholarly Articles 3220231, Harvard University Department of Economics.
  9. Yanqin Fan & Qi Li, 1995. "Bootstrapping J-type tests for non-nested regression models," Economics Letters, Elsevier, vol. 48(2), pages 107-112, May.
  10. Stephen A. Buser & G. Andrew Karolyi & Anthony B. Sanders, . "Adjusted Forward Rates as Predictors of Future Spot Rates," Research in Financial Economics 9605, Ohio State University.
  11. Griffiths, Mark D. & Winters, Drew B., 1995. "Day-of-the-week effects in federal funds rates: Further empirical findings," Journal of Banking & Finance, Elsevier, vol. 19(7), pages 1265-1284, October.
  12. Avraham Kamara, 1988. "Market Trading Structures and Asset Pricing: Evidence from the Treasury- Bill Markets," Review of Financial Studies, Society for Financial Studies, vol. 1(4), pages 357-375.
  13. John B. Carlson & Jean M. McIntire & James B. Thomson, 1995. "Federal funds futures as an indicator of future monetary policy: a primer," Economic Review, Federal Reserve Bank of Cleveland, issue Q I, pages 20-30.
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