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Estimating Nominal Interest Rate Expectations: Overnight Indexed Swaps and the Term Structure

Simon Lloyd

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: Financial market participants and policymakers closely monitor the evolution of interest rate expectations. At any given time, the term structure of interest rates contains information regarding these expectations. No-arbitrage dynamic term structure models have regularly been used to estimate interest rate expectations and term premia, but daily frequency estimates of these models fail to accurately capture the evolution of interest rate expectations implied by surveys and financial market instruments. I propose the augmentation of no-arbitrage Gaussian affine dynamic term structure models (GADTSMs) with overnight indexed swap (OIS) rates in order to better estimate the evolution of interest rate expectations and term premia across the whole term structure. I augment the model with 3 to 24-month OIS rates, which provide accurate information about interest rate expectations. The OIS-augmented model that I propose, estimated between January 2002 and December 2016 for the US, generates estimates of the expected path of short-term interest rates, up to the 10-year horizon, that closely correspond to those implied by federal funds futures rates and survey expectations at a range of horizons, and accurately depict their daily frequency evolution. Against these metrics, the interest rate expectation estimates from OIS-augmented models are superior to estimates from existing GADTSMs.

Keywords: Term Structure of Interest Rates; Overnight Indexed Swaps; Monetary Policy Expectations; Dynamic Term Structure Model. (search for similar items in EconPapers)
JEL-codes: C32 C58 E43 E47 G12 (search for similar items in EconPapers)
Date: 2017-09-20
New Economics Papers: this item is included in nep-mac and nep-mon
Note: spl40
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Related works:
Journal Article: Estimating nominal interest rate expectations: Overnight indexed swaps and the term structure (2020) Downloads
Working Paper: Estimating nominal interest rate expectations: overnight indexed swaps and the term structure (2018) Downloads
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