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Abstract:
Forward and futures rates are frequently used as measures of market expectations. In this paper we apply standard forecast efficiency tests, and some newer exact sign and rank tests, to a wide range of forward and futures rates, and in this way test whether these are in fact rational expectations of future actual prices. The forward and futures rates that we study under a common methodology include foreign exchange forward rates, U.S. and foreign interest rate futures and forward rates, oil futures and natural gas futures. For most, but not all, of these instruments, we find that we can reject the hypothesis that the forward or futures rates are rational expectations of actual future prices. It is well known that foreign exchange forward rates give less accurate forecasts than a random walk, but we show that this is also true for some interest rate futures and forward rates. We conclude that forward and futures prices are not generally pure measures of market expectations: they are also heavily affected by the market price of risk.

forward contracts, futures, forecast evaluation, risk premia, random walk

Abstract:
We examine the asymptotic efficiency of using individual stocks or portfolios as base assets to test cross-sectional asset pricing models. The literature has argued that creating portfolios reduces idiosyncratic volatility and enables factor loadings, and consequently risk premia, to be estimated more precisely. We show analytically and find empirically that the more efficient estimates of betas from creating portfolios do not lead to lower asymptotic variances of factor risk premia estimates. Instead, the standard errors of factor risk premia estimates are determined by the cross-sectional distribution of factor loadings and residual risk. Creating portfolios shrinks the dispersion of betas and leads to higher asymptotic standard errors of risk premia estimates.

Specifying Base Assets, Cross-Sectional Regression, Estimating Risk Premia

Abstract:
Transaction-level data for the federal funds market provide a rare look at the intraday behavior of trade volume and prices. An analysis of the data reveals that trade volume exhibits large swings over the course of the day while prices remain fairly stable, with rate volatility rising sharply only in the late afternoon. The analysis underscores the important role played by institutional deadlines - most notably, the close of trading - in driving movements in this market.

Federal funds market, intraday trading

Abstract:
Widening interest rate spreads observed during the recent financial crisis could represent deteriorating liquidity or greater credit risk. I construct new microstructure measures of credit and liquidity and find that market liquidity effects explain more than two-thirds of the widening of one- and three-month euro LIBOR-OIS spreads and of intra-euro-area sovereign debt spreads over the sample period. My new credit risk measure is an indicator of credit tiering in the interbank money market; my new liquidity measure uses the spread between bonds of differing liquidity that are all guaranteed by the German government, and that therefore should not be contaminated by any effects of credit. Over the sample period, my two measures are nearly orthogonal, making it possible to econometrically identify the separate effects of credit and liquidity. Previous literature finds that risk spreads are largely attributable to default risk, but I ascribe this to their mismeasurement of liquidity and credit.

liquidity, liquidity risk, default risk, interbank markets