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Measuring Monetary Policy Surprises with Rate Futures

Article Quant Q&A · Author: umm
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Summary

The note explains a futures-based method for separating an unexpected policy-rate change from the expected component. The cited approach uses the change in the rate implied by a current-month federal funds futures contract around the policy event, scaled to account for the fact that settlement reflects the month’s average rate. The expected change is then calculated as the actual target-rate change minus the estimated surprise.

The key practical lesson is instrument selection: the example supplied uses Australian stock index futures, which track equity prices rather than overnight interest rates. The answer says the method requires futures on the relevant overnight policy rate and notes that an exact Australian equivalent may not exist. As a result, the formulas cannot be applied to the charted index futures as presented. The exchange gives no alternative Australian instrument or method for constructing the surprise measure.

Key ideas

  • A policy-rate surprise can be estimated from the event-day change in the rate implied by current-month overnight rate futures.
  • The monthly-average settlement feature requires scaling the futures-implied change by the portion of the month affected.
  • The expected policy change is the actual change minus the estimated surprise.
  • Stock index futures are not a substitute for futures tied to an overnight policy rate.
  • The response notes that an exact Australian equivalent to US federal funds futures may not exist.

Tags

Fixed incomeFuturesEvent-drivenStatistics
Full text
# Measuring the surprise element of policy actions


# Measuring the surprise element of policy actions












Dear fellow community members,

Here is the excerpt from Bernanke and Kuttner (2005) that I need to apply to gather my data.

"A measure of the surprise element of any specific change in the Federal funds target can be derived from the change in the futures contract's price relative to the day prior to the policy action. For an event taking place on day d of month m, the unexpected, or "surprise", target funds rate change can be calculated from the change in the rate implied by the current-month futures contract. But because the contract's settlement price is based on the monthly average Federal funds rate, the change in the implied futures rate must be scaled up by a factor related to the number of days in the month affected by the change,

$$ \Delta i^u = \frac{D}{D-d} (f_{m,d}^0 - f_{m,d-1}^0) $$

where $\Delta i^u$ is the unexpected target rate change, $f_{m,d}^0$ is the current-month futures rate, and $D$ is the number of days in the month. The expected component of the rate change is defined as the actual change minus the surprise, or

$$\Delta i^e = \Delta i - \Delta i^u $$

."

I need help applying the above formulas to the Australian Futures Index below. Say there is a surprise change by the RBA (Reserve Bank of Australia) on September 16, what would be the $\Delta i^u$ and $\Delta i^e$? Am i using the right data to measure this? Any help would be very much appreciated as I am very new to finance.

## Answer by dm63 (score 1, accepted)

https://quant.stackexchange.com/a/30181

Your chart shows the prices of stock index futures. That is not what the text is talking about. The text is talking about futures on the overnight federal funds rate. In the US this would be FFU6 for September. I dont think an exact Australian equivalent exists.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.