Extracting the expected path of monetary policy from futures rates

Federal funds and eurodollar futures contracts are among the most useful instruments for deriving expectations of the future path of monetary policy. However, reading policy expectations from those instruments is complicated by the presence of risk premia. This paper demonstrates how to extract the expected policy path under the assumption that risk premia are constant over time, and under a simple model that allows risk premia to vary. In the latter case, the risk premia are identified under the assumption that policy expectations level out after a long enough horizon. The results provide evidence that the risk premia on these futures contracts vary over time. The impact of this variation is fairly limited for futures contracts with short horizons, but it increases as the horizon of the contracts lengthens.