Estimating nominal interest rate expectations: overnight indexed swaps and the term structure

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 02 November 2018

Staff Working Paper No. 763

By Simon P Lloyd

No-arbitrage dynamic term structure models (DTSMs) have regularly been used to estimate interest rate expectations and term premia, but are beset by an identification problem that results in inaccurate estimates. I propose the augmentation of DTSMs with overnight indexed swap (OIS) rates to better estimate interest rate expectations and term premia along the whole term structure at daily frequencies. I illustrate this with a Gaussian affine DTSM augmented with 3 to 24-month OIS rates, which provide accurate information about interest rate expectations. The OIS-augmented model generates estimates of US interest rate expectations that closely correspond to those implied by federal funds futures rates and survey expectations out to a 10-year horizon, accurately depict their daily frequency evolution, and are more stable across samples. Against these metrics, interest rate expectation estimates, and therefore term premia, from OIS-augmented models are superior to estimates from existing Gaussian affine DTSMs.

PDFEstimating nominal interest rate expectations: overnight indexed swaps and the term structure

Was this page useful?
Add your details...