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of Connecticut. This paper has benefitted from useful comments from Kerry Back,
BibTeX
@MISC{Farnsworth_ofconnecticut.,
author = {Heber Farnsworth and Richard Bass and Pierre Collin-dufresne and Greg Duffee and Darrell Duffie and Phil Dybvig and Bob Goldstein and Richard Stanton and Daniel Thornton and Seminar Participants},
title = {of Connecticut. This paper has benefitted from useful comments from Kerry Back,},
year = {}
}
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Abstract
The Federal Reserve sets targets for interest rates which it enforces through direct market intervention. These targets are changed periodically. In this paper we develop a term structure model in which the short rate is subject to a control which keeps it close to a target which changes from time to time. The probability of target changes is not constant in the model but changes as a function of observables. The model performs well at explaining the shifts in the yield curve that accompany target changes. In U.S. financial markets the Federal Reserve Bank (the Fed) is a unique player. Usually we assume that market participants are price takers in financial markets. However, there is evidence that this is not true of the Fed. In fact, the Fed sets targets for short-term rates which it attempts to maintain by market intervention, injecting or withdrawing funds from the market to keep the rates near their targets. Targets are changed from time to time and market participants know when such a target change occurs. They may, in fact, have some limited ability to forecast such target changes.
Keyphrases
kerry back target change useful comment market participant u.s. financial market term structure model financial market federal reserve accompany target change interest rate federal reserve bank unique player market intervention limited ability short rate yield curve short-term rate price taker direct market intervention
