The Relation between Default-Free Interest Rates and Expected Economic Growth Is Stronger Than You Think

Avraham Kamara

Journal of Finance, 1997, vol. 52, issue 4, 1681-94

Abstract: The relation between default-free interest rates and expected economic growth is substantially stronger than suggested by extant literature. Futures-implied Treasury bill yield spreads are more highly correlated with future real consumption, investment, and GNP growth than spot spreads. This stronger relation arises because using futures removes a component of the spot term structure that covaries negatively with real economic growth. Treasury forward rates from spot bills contain a premium for the risk that short-sellers will default. This risk premium is negatively related to expected economic growth. Copyright 1997 by American Finance Association.

Date: 1997
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