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Predicting the Fed

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Author Info

  • Kenneth B. Petersen

    (Laffer Associates and University of Connecticut)

  • Vladimir Pozdnyakov

    (University of Connecticut)

Abstract

Predicting the federal funds rate and beating the federal funds futures market: mission impossible? Not so. We employ a Markov transition process and show that this model outperforms the federal funds futures market in predicting the target federal funds rate. Thus, by using purely historical data we are able to better explain future monetary policy than a forward looking measure like the federal funds futures rate. The fact that the federal funds futures market can be beaten by a statistical model, suggests that the federal funds futures market lacks eciency. The mar- ket allocates too much weight to current Federal Reserve communication and other real-time macro events, and allocates too little weight to past monetary policy behavior.

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File URL: http://www.econ.uconn.edu/working/2008-07.pdf
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Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2008-07.

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Length: 25 pages
Date of creation: Mar 2008
Date of revision:
Handle: RePEc:uct:uconnp:2008-07

Note: The views expressed here do not necessarily reflect the opinion and views of Laffer Associates.
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Postal: University of Connecticut 341 Mansfield Road, Unit 1063 Storrs, CT 06269-1063
Phone: (860) 486-4889
Fax: (860) 486-4463
Web page: http://www.econ.uconn.edu/
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Related research

Keywords: Monetary policy; Federal funds futures market; Markov modeling;

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References

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  1. Jeff Moore & Richard Austin, 2002. "The behavior of federal funds futures prices over the monetary policy cycle," Economic Review, Federal Reserve Bank of Atlanta, issue Q2, pages 45-61.
  2. Kenneth N. Kuttner, 2000. "Monetary policy surprises and interest rates: evidence from the Fed funds futures markets," Staff Reports 99, Federal Reserve Bank of New York.
  3. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2002. "Market-based measures of monetary policy expectations," Finance and Economics Discussion Series 2002-40, Board of Governors of the Federal Reserve System (U.S.).
  4. Faust, Jon & Swanson, Eric T. & Wright, Jonathan H., 2004. "Identifying VARS based on high frequency futures data," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1107-1131, September.
  5. William Poole & Robert H. Rasche, 2000. "Perfecting the market's knowledge of monetary policy," Working Papers 2000-010, Federal Reserve Bank of St. Louis.
  6. John H. Cochrane & Monika Piazzesi, 2002. "The Fed and Interest Rates: A High-Frequency Identification," NBER Working Papers 8839, National Bureau of Economic Research, Inc.
  7. John C. Robertson & Ellis W. Tallman, 1999. "Improving forecasts of the federal funds rate in a policy model," Working Paper 99-3, Federal Reserve Bank of Atlanta.
  8. John C. Robertson & Daniel L. Thornton, 1997. "Using federal funds futures rates to predict Federal Reserve actions," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 45-53.
  9. Söderlind, Paul & Söderström, Ulf & Vredin, Anders, 2003. "Taylor Rules and the Predictability of Interest Rates," CEPR Discussion Papers 3934, C.E.P.R. Discussion Papers.
  10. Swanson, Eric T., 2006. "Have Increases in Federal Reserve Transparency Improved Private Sector Interest Rate Forecasts?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(3), pages 791-819, April.
  11. Lange, Joe & Sack, Brian & Whitesell, William, 2003. " Anticipations of Monetary Policy in Financial Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(6), pages 889-909, December.
  12. John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, vol. 95(1), pages 138-160, March.
  13. Refet S. Gürkaynak, 2005. "Using federal funds futures contracts for monetary policy analysis," Finance and Economics Discussion Series 2005-29, Board of Governors of the Federal Reserve System (U.S.).
  14. Charles L. Evans, 1998. "Real-time Taylor rules and the federal funds futures market," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 44-55.
  15. Monika Piazzesi & Eric Swanson, 2004. "Future prices as risk-adjusted forecasts of monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  16. William Poole, 2005. "How predictable is Fed policy?," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 659-68.
  17. William Poole, 2007. "Understanding the Fed," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 3-14.
  18. Monika Piazzesi, 2005. "Bond Yields and the Federal Reserve," Journal of Political Economy, University of Chicago Press, vol. 113(2), pages 311-344, April.
  19. William Poole, 2000. "How well do the markets understand Fed policy?," Speech 64, Federal Reserve Bank of St. Louis.
  20. Joel T. Krueger & Kenneth N. Kuttner, 1995. "The Fed funds futures rate as a predictor of Federal Reserve policy," Working Paper Series, Macroeconomic Issues 95-4, Federal Reserve Bank of Chicago.
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Cited by:
  1. Bernd Hayo & Matthias Neuenkirch, 2009. "Do Federal Reserve Communications Help Predict Federal Funds Target Rate Decisions?," MAGKS Papers on Economics 200925, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).

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