The forecasting power of forward interest rates and the slope of the yield curve in the Canadian treasury bill market
Date
1988
Authors
Eaton, Brenda
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Abstract
This thesis analyzes the power of the forward interest rate and the slope of the yield curve in predicting future interest rates, by comparing their predictive ability against that of the martingale model. It also examines whether an adjustment for a risk premium improves the predictive power of the forward and the slope. The premium is calculated on several different bases, the most effective of which is based on an ARIMA model. The data in this thesis are 3- and 6-month Canadian Treasury Bills over the period January 1960 to March 1988.
The finding of this thesis is that the forward rate and the slope of the yield curve are little better than the martingale model at forecasting future interest rates. While an adjustment for a risk premium improves their predictive power, the improvement is only marginal.
This finding has important implications to monetary authorities, who may seek to influence interest rate movements, and to private (or public) sector borrowers or lenders who might attempt to extract information about future interest rates from the forward or slope.