Working Paper: CEPR ID: DP14800
Authors: Michael R. Wickens
Abstract: A feature of the financial crisis rarely mentioned in the academic literature is that forward interest rates remained persistently higher than future spot rates. Yet according to the expectations hypothesis forward interest rates are unbiased predictors of future spot rates. More general theories attribute the forecast errors to term premia. This paper examines whether these theories can explain data for the US and UK that spans the financial crisis and whether alternative approaches provide better forecasts. The main findings are that these theories break down after the financial crisis and, not unexpectedly, that the forecast errors are due mainly to monetary policy.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Forward interest rates (E43) | Future spot rates (E43) |
| Forward interest rates (E43) | Forecasting errors (C53) |
| Term premia (Y20) | Forward interest rates (E43) |
| Macroeconomic factors (E66) | Forecasting errors (C53) |
| Forecast horizon (G17) | Term premia (Y20) |