Abstract
This paper sheds light on Swiss franc LIBOR futures, which are often used to derive interest rate expectations. We show that the differences between LIBOR futures and realized rates (excess returns) are, on average, positive over the last 25 years. Using interest rate surveys, we decompose excess returns into a (forward) term premium and forecast errors. The decomposition reveals that the bulk of excess returns arises from forecast errors, while the term premium is, on average, zero but time varying. We find that the term premium positively correlates with the business cycle, interest rate developments, and in absolute values increases with interest rate uncertainty.
Highlights
Predicting the future path of monetary policy is of great importance for financial market participants
In terms of economic magnitude, the results indicate that a one standard deviation increase in the business cycle index is associated with a roughly 0.1 standard deviation increase in the term premium
We find that excess returns are, on average, positive and statistically significant
Summary
Predicting the future path of monetary policy is of great importance for financial market participants. Beside the model-free approach, there are a variety of term structure models estimating the term premium directly from the yield curve (for an overview see, for example, Kim and Orphanides (2007), Gibson et al (2010) or Cohen et al (2018)) Some of these models make use of survey data as additional model input to better pin down the future path of short rates to overcome estimation problems. Kugler (1996, 1997) provide evidence for a time-varying term premium in shortterm rates This result is confirmed by Gerlach-Kristen (2007) for long-term government bonds, while at the short-end of the yield curve the expectation hypothesis cannot be rejected. They find an asymmetric relationship during the period when interest rates were at zero, while the asymmetry was reduced when interest rates were effectively negative
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