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Do Federal Funds Futures Need Adjustment for Excess Returns? A State-Dependent Approach By Brent Bundick |
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Abstract This paper utilizes a Markov-switching framework to model
excess returns in federal funds futures contracts. This framework identifies
a high-volatility state where excess returns are large, positive, and
volatile and a low-volatility state where excess returns have a lower
volatility and are small in absolute value. Federal funds futures rates
require adjustment for excess returns only in the high-volatility state.
Intermeeting rate cuts of the federal funds rate target always correspond
with the high-volatility regime and can explain much of the variation in
excess returns. This paper also examines previous return models and helps
clarify the relationship between excess returns, business cycles, and
intermeeting rate cuts. In real-time forecasting, however, the unadjusted
futures rates outperform three different forecasting models. This result
strengthens the case for unadjusted futures rates as a measure of monetary
policy expectations. Back to top RWP home |