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Estimating nominal interest rate expectations: Overnight indexed swaps and the term structure

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  • Lloyd, Simon P.

Abstract

No-arbitrage dynamic term structure models (DTSMs) have regularly been used to estimate interest rate expectations and term premia, but are beset by empirical challenges. I propose augmenting DTSMs with overnight indexed swap (OIS) rates to better estimate the decomposition along the term structure at daily frequencies. A Gaussian affine DTSM, augmented with 3 to 24-month OIS rates, generates estimates of US expectations that closely correspond to survey-implied measures out to a 10-year horizon and are more stable across sub-samples, compared to existing models. In addition, I provide narrative evidence, in the form of an event study around US unconventional monetary policy announcements, to further exemplify the benefits from OIS augmentation.

Suggested Citation

  • Lloyd, Simon P., 2020. "Estimating nominal interest rate expectations: Overnight indexed swaps and the term structure," Journal of Banking & Finance, Elsevier, vol. 119(C).
  • Handle: RePEc:eee:jbfina:v:119:y:2020:i:c:s0378426620301771
    DOI: 10.1016/j.jbankfin.2020.105915
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    Cited by:

    1. Bailey, Andrew & Bridges, Jonathan & Harrison, Richard & Jones, Josh & Mankodi, Aakash, 2020. "The central bank balance sheet as a policy tool: past, present and future," Bank of England working papers 899, Bank of England.
    2. Darmouni, Olivier & Geisecke, Oliver & Rodnyanky, Alexander, 2019. "The Bond Lending Channel of Monetary Policy," MPRA Paper 95141, University Library of Munich, Germany.
    3. Giancarlo Corsetti & Joao B. Duarte & Samuel Mann, 2020. "One Money, Many Markets: Monetary Transmission and Housing Financing in the Euro Area," IMF Working Papers 2020/108, International Monetary Fund.
    4. Lloyd, S. P., 2017. "Overnight Indexed Swap Market-Based Measures of Monetary Policy Expectations," Cambridge Working Papers in Economics 1733, Faculty of Economics, University of Cambridge.
    5. Giancarlo Corsetti & Joao B Duarte & Samuel Mann, 2022. "One Money, Many Markets [Fixed Rate Versus Adjustable Rate Mortgages: Evidence from Euro Area Banks]," Journal of the European Economic Association, European Economic Association, vol. 20(1), pages 513-548.
    6. Corsetti, G. & Duarte, J. B. & Mann, S., 2018. "One Money, Many Markets - A Factor Model Approach to Monetary Policy in the Euro Area with High-Frequency Identification," Cambridge Working Papers in Economics 1816, Faculty of Economics, University of Cambridge.
    7. He, Zhen & O’Connor, Fergal & Thijssen, Jacco, 2022. "Identifying proxies for risk-free assets: Evidence from the zero-beta capital asset pricing model," Research in International Business and Finance, Elsevier, vol. 63(C).

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    More about this item

    Keywords

    Dynamic term structure model; Monetary policy expectations; Overnight indexed swaps; Term premia; Term structure of interest rates;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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