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Predicting monetary policy using federal funds futures prices

In theory, prices of current-month federal funds futures contracts should reflect market expectations of near-term movements in the Federal Reserve's target level for the federal funds rate. However, empirical results show that such measures of market expectations are too noisy to predict day-to-day changes in the funds rate target; partly due to time aggregation problems, partly because they are affected by funds rate movements not directly related to monetary policy considerations. In particular, the futures market shows a large amount of systematic variation across months and trading days, variation that needs to be taken into account when predicting policy moves or extracting policy expectations. For the period from January 1994 to February 1998, the extracted expectations perform fairly well in predicting the target level that will prevail after the next meeting of the Federal Open Market Committee, expecially when adjusting for market regularities.

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Paper provided by Stockholm School of Economics in its series SSE/EFI Working Paper Series in Economics and Finance with number 307.

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Length: 32 pages
Date of creation: 08 Mar 1999
Date of revision:
Publication status: Published in Journal of Futures Markets, 2001, pages 377-391.
Handle: RePEc:hhs:hastef:0307
Contact details of provider: Postal: The Economic Research Institute, Stockholm School of Economics, P.O. Box 6501, 113 83 Stockholm, Sweden
Phone: +46-(0)8-736 90 00
Fax: +46-(0)8-31 01 57
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  1. Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory 95-02, Federal Reserve Bank of San Francisco.
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  3. Allen, Linda & Saunders, Anthony, 1992. "Bank window dressing: Theory and evidence," Journal of Banking & Finance, Elsevier, vol. 16(3), pages 585-623, June.
  4. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
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  6. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  7. Ellingsen, Tore & Söderström, Ulf, 1998. "Monetary Policy and Market Interest Rates," SSE/EFI Working Paper Series in Economics and Finance 242, Stockholm School of Economics, revised 08 Mar 1999.
  8. Michael R. Pakko & David C. Wheelock, 1996. "Monetary policy and financial market expectations: what did they know and when did they know it?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 19-32.
  9. 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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  12. V. Vance Roley & Gordon H. Sellon, 1996. "The response of the term structure of interest rates to federal funds rate target changes," Research Working Paper 96-08, Federal Reserve Bank of Kansas City.
  13. Daniel L. Thornton, 1996. "Does the Fed's new policy of immediate disclosure affect the market?," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 77-88.
  14. Charles Evans & Kenneth Kuttner, 1998. "Can VARs describe monetary policy?," Research Paper 9812, Federal Reserve Bank of New York.
  15. Ho, Thomas S Y & Saunders, Anthony, 1985. " A Micro Model of the Federal Funds Market," Journal of Finance, American Finance Association, vol. 40(3), pages 977-88, July.
  16. Spindt, Paul A. & Hoffmeister, J. Ronald, 1988. "The Micromechanics of the Federal Funds Market: Implications for Day-of-the-Week Effects in Funds Rate Variability," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 23(04), pages 401-416, December.
  17. Saunders, Anthony & Urich, Thomas, 1988. "The effects of shifts in monetary policy and reserve accounting regimes on bank reserve management behavior in the federal funds market," Journal of Banking & Finance, Elsevier, vol. 12(4), pages 523-535, December.
  18. 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.
  19. Joel T. Krueger & Kenneth N. Kuttner, 1996. "The Fed funds futures rate as a predictor of federal reserve policy," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 16(8), pages 865-879, December.
  20. 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.
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