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Studies in Nonlinear Dynamics & Econometrics

Ed. by Mizrach, Bruce


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Volume 24 (2020)

What model for the target rate

Bruno Feunou / Jean-Sébastien Fontaine / Jianjian Jin
Published Online: 2020-01-23 | DOI: https://doi.org/10.1515/snde-2019-0005

Abstract

The Federal Reserve target rate has a lower bound. Changes to the target rate occur with discrete increments. Using out-of-sample forecasts of the target rate, we evaluate models incorporating these two realistic non-linear features. Incorporating these features mitigates in-sample over-fitting and improves out-of-sample forecast accuracy of the target rate level and volatility. A model with these features performs better relative to the linear models because (i) it produces stronger responses of forecasts to inflation and unemployment and a weaker response to lagged target rate, and because (ii) it yields very different forecast distributions when the target rate is close to the lower bound.

This article offers supplementary material which is provided at the end of the article.

Keywords: financial markets; interest rates

JEL Classification: E43

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About the article

Published Online: 2020-01-23


Citation Information: Studies in Nonlinear Dynamics & Econometrics, 20190005, ISSN (Online) 1558-3708, DOI: https://doi.org/10.1515/snde-2019-0005.

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