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Federal Funds Rate Prediction

Author

Listed:
  • Sarno, Lucio

    (University of Warwick)

  • Daniel l Thornton
  • Giorgio Valente

Abstract

Recent research has reported that both the federal funds rate futures market and the federal funds target contain valuable information for explaining the behavior of the US effective federal funds rate. A parallel literature on interest rate modelling has recorded evidence that the dynamics of interest rates displays significant regime-switching behavior. In this paper we produce out of sample forecasts of the federal funds rate at horizons up to 8 weeks ahead using linear and nonlinear, regime-switching equilibrium correction models of the funds rate and employing both point and density measures of forecast accuracy. We cannot discriminate among the models considered in terms of point forecast accuracy. However, in terms of density forecast accuracy, we find that the term structure model of the federal funds futures rate is significantly better than the other models considered, and that regime-switching models provide a substantial forecasting improvement relative to their linear counterparts and relative to individual series of the futures rate.

Suggested Citation

  • Sarno, Lucio & Daniel l Thornton & Giorgio Valente, 2003. "Federal Funds Rate Prediction," Royal Economic Society Annual Conference 2003 183, Royal Economic Society.
    • Handle: RePEc:ecj:ac2003:183
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    JEL classification:

    • 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

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