Abstract: This paper examines estimates of the term premium on federal funds
futures rates, with a focus on near-dated contracts and therefore the more
immediate policy horizon. The first set of methods assumes that the term
premium is constant over time. Under this framework, calculations that use
survey data to proxy for forecast errors produce more intuitive results than
estimates based on the restrictive assumption that forecast errors average
to zero over the sample. The second set of methods allows the term premium
to vary over time, but the results based on the term structure of near-dated
federal funds futures contracts are highly volatile, which perhaps reflects
numerous technical factors in the underlying federal funds market. Finally,
under an asset-pricing approach, the CAPM suggests that the risk premium on
federal funds futures is either less than or equal to zero, while APT indicates
that it can be positive.
Keywords: Federal funds futures, term premium, expectations hypothesis
Full paper (364 KB PDF)
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