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What are the odds? option-based forecasts of FOMC target changes

Author

Listed:
  • William R. Emmons
  • Aeimit K. Lakdawala
  • Christopher J. Neely

Abstract

This article uses probability forecasts derived from options to assess evolving market uncertainty about Federal Reserve monetary policy actions in a variety of recent events and episodes. Options on federal funds futures contracts reveal a complete probability density function over possible Federal Reserve target rates, thus augmenting the expectations provided by federal funds futures contracts. Option-based forecasts are most useful when more than two federal funds target outcomes are plausible at an upcoming policy meeting.

Suggested Citation

  • William R. Emmons & Aeimit K. Lakdawala & Christopher J. Neely, 2006. "What are the odds? option-based forecasts of FOMC target changes," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 543-562.
  • Handle: RePEc:fip:fedlrv:y:2006:i:nov:p:543-562:n:v.88no.6
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    File URL: https://files.stlouisfed.org/files/htdocs/publications/review/06/11/Emmons.pdf
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    References listed on IDEAS

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    1. Sarno, Lucio & Thornton, Daniel L & Valente, Giorgio, 2005. "Federal Funds Rate Prediction," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(3), pages 449-471, June.
    2. Christopher J. Neely, 2005. "Using implied volatility to measure uncertainty about interest rates," Review, Federal Reserve Bank of St. Louis, issue May, pages 407-425.
    3. Soderlind, Paul & Svensson, Lars, 1997. "New techniques to extract market expectations from financial instruments," Journal of Monetary Economics, Elsevier, vol. 40(2), pages 383-429, October.
    4. Peter Hördahl & David Vestin, 2005. "Interpreting Implied Risk-Neutral Densities: The Role of Risk Premia," Review of Finance, Springer, vol. 9(1), pages 97-137, March.
    5. Christopher J. Neely, 2004. "Miscommunication shook up mortgage, bond markets," The Regional Economist, Federal Reserve Bank of St. Louis, issue Apr, pages 4-9.
    6. Piazzesi, Monika & Swanson, Eric T., 2008. "Futures prices as risk-adjusted forecasts of monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(4), pages 677-691, May.
    7. Brian Sack, 2004. "Extracting the Expected Path of Monetary Policy From Futures Rates," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 24(8), pages 733-754, August.
    8. Peter A. Abken, 1995. "Using Eurodollar futures options: gauging the market's view of interest rate movements," Economic Review, Federal Reserve Bank of Atlanta, issue Mar, pages 10-30.
    9. William Poole & Robert H & Rasche & Daniel L. Thornton, 2002. "Market anticipations of monetary policy actions," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 65-94.
    10. Christopher J. Neely, 2003. "Bond market mania," Monetary Trends, Federal Reserve Bank of St. Louis, issue Oct.
    11. Bliss, Robert R. & Panigirtzoglou, Nikolaos, 2002. "Testing the stability of implied probability density functions," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 381-422, March.
    12. John B. Carlson & Ben R. Craig & William R. Melick, 2005. "Recovering market expectations of FOMC rate changes with options on federal funds futures," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 25(12), pages 1203-1242, December.
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    Cited by:

    1. Renne, Jean-Paul, 2016. "A tractable interest rate model with explicit monetary policy rates," European Journal of Operational Research, Elsevier, vol. 251(3), pages 873-887.
    2. Bo Young Chang & Bruno Feunou, 2013. "Measuring Uncertainty in Monetary Policy Using Implied Volatility and Realized Volatility," Staff Working Papers 13-37, Bank of Canada.

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