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

55 Pages Posted: 6 Nov 2018

Date Written: November 2, 2018

Abstract

No-arbitrage dynamic term structure models (DTSMs) have regularly been used to estimate interest rate expectations and term premia, but are beset by an identification problem that results in inaccurate estimates. I propose the augmentation of DTSMs with overnight indexed swap (OIS) rates to better estimate interest rate expectations and term premia along the whole term structure at daily frequencies. I illustrate this with a Gaussian affine DTSM augmented with 3 to 24-month OIS rates, which provide accurate information about interest rate expectations. The OIS-augmented model generates estimates of US interest rate expectations that closely correspond to those implied by federal funds futures rates and survey expectations out to a 10-year horizon, accurately depict their daily frequency evolution, and are more stable across samples. Against these metrics, interest rate expectation estimates, and therefore term premia, from OIS-augmented models are superior to estimates from existing Gaussian affine DTSMs.

Keywords: Dynamic term structure model, monetary policy expectations, overnight indexed swaps, term premia, term structure of interest rates

JEL Classification: C32, C58, E43, E47, G12

Suggested Citation

Lloyd, Simon, Estimating Nominal Interest Rate Expectations: Overnight Indexed Swaps and the Term Structure (November 2, 2018). Bank of England Working Paper No. 763. Available at SSRN: https://ssrn.com/abstract=3278602 or http://dx.doi.org/10.2139/ssrn.3278602

Simon Lloyd (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

HOME PAGE: http://https://sites.google.com/view/splloyd

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