Market Anticipation of Fed Policy Changes and the Term Structure of Interest Rates*

Abstract

The Federal Reserve adjusts the federal funds target rate discretely, causing discontinuity in short-term interest rates. Unlike Poisson jumps, these adjustments are well anticipated by the market. We propose a term structure model that incorporates an anticipated jump component with known arrival times but random jump size. We find that doing so improves the model performance in capturing the term structure behavior. The mean jump sizes extracted from the term structure match the realized target rate changes well. Specification analysis indicates that the jump sizes show strong serial dependence and dependence on the interest-rate factors.

Another Look at the Stock Return Response to Monetary Policy Actions*

“…Balduzzi, Bertola, and Foresi (1997) andHeidari and Wu (2010) provide evidence that short-term interest rates anticipate future changes in the Fed funds rate target.6 In the article, I use interchangeably the terms monetary policy actions and shocks. However, some authors use "monetary policy actions" to refer to the total change in the Fed funds rate (ÁFFR), and use "monetary policy shocks" as denoting the unexpected or surprise change in monetary policy, for which FFPREM should be a convenient proxy.330 P. MAIO at Universita degli Studi di Torino on March 10, 2014 http://rof.oxfordjournals.org/ Downloaded from…”

Discretely Distributed Scheduled Jumps and Interest Rate Derivatives: Pricing in the Context of Central Bank Actions

“…Recognizing this limitation, recent studies have proposed ground-breaking approaches that introduce jumps with scheduled deterministic times into interest rate models. The use of Gaussian distribution for the size of scheduled jumps has been implemented in several studies, such as Heidari and Wu (2009), Kim and Wright (2014), Schloegl et al (2023), and Fontana et al (2024). By entering these deterministic jump times triggered by monetary authority meetings into the framework of interest rate models, the aim is to better encapsulate scheduled adjustments in interest rates triggered by central bank meetings.…”

“…The class of models developed here, named the AJD-Skellam model, can be viewed as a forward step in reference to Piazzesi (2005); Heidari and Wu (2009); Kim and Wright (2014); Backwell and Hayes (2022); Schloegl et al (2023), andFontana et al (2024), as it presents the following novel features.…”

“…The model class introduced herein advances beyond existing models in the literature, such as Heidari and Wu (2009), Kim andWright (2014), andFontana et al (2024), by encompassing not only diffusive dynamics but also integrating instantaneous interest rate jumps according to a discrete distribution at predetermined times. Furthermore, this class enables analytical derivation of the characteristic function, facilitating computationally efficient calculations for both bonds and derivative instruments.…”

Staying on Top of the Curve: A Cascade Model of Term Structure Dynamics

“…The National Bureau of Economic Research has identified 33 business cycles over the 156-year period between 1854 and 2009.3 See alsoAng, Dong, and Piazzesi (2007),Ang, Piazzesi, and Wei (2004),Balduzzi, Bertola, and Foresi (1997),Bekaert, Cho, and Moreno (2005),Gallmeyer, Hollifield, Palomino, and Zin (2005),Heidari and Wu (2010),Hördahl, Tristanoi, and Vestin (2006),Lu and Wu (2009),Rudebusch (2002), andRudebusch, Swanson, and Wu (2006).…”