Estimating Nominal Interest Rate Expectations: Overnight Indexed Swaps and the Term Structure
61 Pages Posted: 11 Sep 2020
Date Written: July 31, 2020
No-arbitrage dynamic term structure models (DTSMs) have regularly been used to estimate interest rate expectations and term premia, but are beset by empirical challenges. I propose augmenting DTSMs with overnight indexed swap (OIS) rates to better estimate the decomposition along the term structure at daily frequencies. A Gaussian affine DTSM, augmented with 3 to 24-month OIS rates, generates estimates of US expectations that closely correspond to survey-implied measures out to a 10-year horizon and are more stable across sub-samples, compared to existing models. In addition, I provide narrative evidence, in the form of an event study around US unconventional monetary policy announcements, to further exemplify the benefits from OIS augmentation.
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: Suggested Citation