Recovering Market Expectations of FOMC Rate Changes With Options on Federal Funds Futures
50 Pages Posted: 31 Oct 2007
Date Written: July 2005
Abstract
This paper demonstrates how options on federal funds futures, which began trading in March 2003, can be used to recover the implied probability density function (PDF) for future Federal Open Market Committee (FOMC) interest rate outcomes. The discrete nature of the choices made by the FOMC allows for a very straightforward recovery of the implied PDF using ordinary least squares (OLS) estimation. This simple recovery method stands in contrast to the relatively complicated PDF recovery techniques developed for options written on assets such as equities, foreign exchange, or commodity futures where the underlying prices are most appropriately modeled as being drawn from continuous distributions. The OLS estimation is used to recover PDFs for single FOMC meetings as well as PDFs for joint estimation of multiple FOMC meetings, and allows for the imposition of restrictions on the recovered probabilities, both within and across FOMC meetings. Finally, recovered probabilities are used to assess the impact of data releases and Fed communication on the perceived likelihood of actual policy outcomes.
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Dynamics of the Federal Funds Target Rate: A Nonstationary Discrete Choice Approach
By Ling Hu and Peter C. B. Phillips
-
By Ling Hu and Peter C. B. Phillips
-
Maximum Score Estimation of a Nonstationary Binary Choice Model
-
Dynamic Limited Dependent Variable Modeling and US Monetary Policy
-
Probability Elicitation, Scoring Rules, and Competition Among Forecasters
-
Forecast Combination for Discrete Choice Models: Predicting FOMC Monetary Policy Decisions
-
Nonstationary Discrete Choice: A Corrigendum and Addendum
By Peter C. B. Phillips, Sainan Jin, ...
-
A Study of a Semiparametric Binary Choice Model with Integrated Covariates