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

61 Pages Posted: 11 Sep 2020

Multiple version iconThere are 2 versions of this paper

Date Written: July 31, 2020

Abstract

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

Lloyd, Simon, Estimating Nominal Interest Rate Expectations: Overnight Indexed Swaps and the Term Structure (July 31, 2020). Journal of Banking and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3665304

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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