Monetary Policy Expectations and Risk Premiums in the U.S.: Evidence from the Ois Curve

Abstract

This paper examines the usefulness of OIS rates as measures of policy expectations in the US. We show that macro factors are hidden in the OIS rates. Using a model with hidden factors we decompose OIS rates into expectations and risk premia. Decomposition shows that risk premia are negligible in the OIS rates with maturities up to 1-year, but sizable in longer maturities. We show that model implied expectations forecast policy rates better compared to other alternatives. We argue that higher expected inflation contributed to higher policy rate expectations whereas risk premiums go up with real and nominal risks.

Keywords: Monetary Policy Expectations, Overnight index swaps, Affine Term Structure Models