Predicting the Fed: Do futures need risk adjustment?
39 Pages Posted: 27 May 2020 Last revised: 27 Apr 2022
Date Written: April 29, 2020
Do fed funds futures need adjustment for risk premia? I study the predictability of time-varying risk premia in fed funds futures and find that standard predictor variables do not outperform the expectations hypothesis when evaluated out-of-sample. I apply the advanced forecasting methods Dynamic Model Averaging and Complete Subset Regressions to account for model instability and find considerably more accurate return predictions than from simple linear prediction models. These predictions do not, however, yield systematic economic value to investors, showing that federal funds futures do not need adjustment for time-varying risk premia when used to gauge market participants' expectations of future Fed policy.
Keywords: Return Predictability; Federal Funds Futures; Expectations Hypothesis; Monetary Policy
JEL Classification: E43, E47, C53, C58, G11, G12
Suggested Citation: Suggested Citation