Keywords: Bond options, nominal rate zero bound, term premiums
Abstract: The term structure of interest rates is the primary transmission
channel of monetary policy. Under the expectations hypothesis,
anticipated settings of the short-term interest rate controlled by the
central bank are the main determinants of nominal bond rates.
Historical experience suggests that bond rates may remain relatively
high even if the short-term interest rate is reduced to zero, in part
due to term premiums reflecting uncertainty about future policy. Term
spreads due to policy uncertainty may be reduced by central bank
trading desk options that provide insurance against future deviations
from an announced interest rate policy.
Full paper (204 KB PDF)
| Full paper (472 KB Postscript)
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Last update: March 19, 1999