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Predicting the Fed

Author

Listed:
  • 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.

Suggested Citation

  • Kenneth B. Petersen & Vladimir Pozdnyakov, 2008. "Predicting the Fed," Working papers 2008-07, University of Connecticut, Department of Economics.
  • 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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    References listed on IDEAS

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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, pages 45-61.
    2. 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.
    3. Kuttner, Kenneth N., 2001. "Monetary policy surprises and interest rates: Evidence from the Fed funds futures market," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 523-544, June.
    4. Gurkaynak, Refet S. & Sack, Brian T. & Swanson, Eric P., 2007. "Market-Based Measures of Monetary Policy Expectations," Journal of Business & Economic Statistics, American Statistical Association, vol. 25, pages 201-212, April.
    5. 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.
    6. William Poole, 2005. "How predictable is Fed policy?," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 659-668.
    7. John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, pages 138-160.
    8. Robertson, John C & Tallman, Ellis W, 2001. "Improving Federal-Funds Rate Forecasts in VAR Models Used for Policy Analysis," Journal of Business & Economic Statistics, American Statistical Association, vol. 19(3), pages 324-330, July.
    9. 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.
    10. 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.
    11. William Poole, 2000. "How well do the markets understand Fed policy?," Speech 64, Federal Reserve Bank of St. Louis.
    12. Monika Piazzesi, 2005. "Bond Yields and the Federal Reserve," Journal of Political Economy, University of Chicago Press, vol. 113(2), pages 311-344, April.
    13. William Poole & Robert Rasche, 2000. "Perfecting the Market's Knowledge of Monetary Policy," Journal of Financial Services Research, Springer;Western Finance Association, pages 255-298.
    14. Söderlind, Paul & Söderström, Ulf & Vredin, Anders, 2003. "Taylor Rules and the Predictability of Interest Rates," Working Paper Series 147, Sveriges Riksbank (Central Bank of Sweden).
    15. 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.
    16. William Poole, 2007. "Understanding the Fed," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 3-14.
    17. Monika Piazzesi, 2002. "The Fed and Interest Rates - A High-Frequency Identification," American Economic Review, American Economic Association, pages 90-95.
    18. 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.
    19. 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.).
    20. 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.
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    Citations

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    Cited by:

    1. Hayo, Bernd & Neuenkirch, Matthias, 2010. "Do Federal Reserve communications help predict federal funds target rate decisions?," Journal of Macroeconomics, Elsevier, pages 1014-1024.
    2. Hayo, Bernd & Neuenkirch, Matthias, 2010. "Do Federal Reserve communications help predict federal funds target rate decisions?," Journal of Macroeconomics, Elsevier, pages 1014-1024.

    More about this item

    Keywords

    Monetary policy; Federal funds futures market; Markov modeling;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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