Funding Shortages, Expectations, and Forward Rate Risk Premium

35 Pages Posted: 27 Feb 2020

See all articles by Robert Jarrow

Robert Jarrow

Cornell SC Johnson College of Business

Sujan Lamichhane

Johns Hopkins University - Carey Business School

Date Written: February 1, 2020

Abstract

This paper estimates term risk premium and expected future spot rates embedded in Treasury forward rates to study the impact of short-term funding shortages on these quantities. Our approach is consistent with dynamic equilibrium models and avoids the arbitrage-free dynamic inconsistency problems exhibited by traditional methods. We find that short-term funding shortages in money markets affect both expectations of spot rates and forward rate risk premium for all maturity forward rates. The leverage ratio of intermediaries (primary dealers) significantly affects term risk premium but not expectations of future spot rates. Yield curve inversion has no impact on the forward rate curve’s evolution.

Keywords: funding shortages; forward rates; term risk premium; financial intermediary leverage ratios; expectations hypothesis; inverted yield curves

JEL Classification: G12, G20, E43

Suggested Citation

Jarrow, Robert and Lamichhane, Sujan, Funding Shortages, Expectations, and Forward Rate Risk Premium (February 1, 2020). Available at SSRN: https://ssrn.com/abstract=3538457 or http://dx.doi.org/10.2139/ssrn.3538457

Robert Jarrow (Contact Author)

Cornell SC Johnson College of Business

Ithaca, NY 14850
United States

Sujan Lamichhane

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

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