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Board of Governors of the Federal Reserve System

International Finance Discussion Papers

Number 720

February 2002

IDENTIFYING VARS BASED ON HIGH FREQUENCY FUTURES DATA

Jon Faust, Eric Swanson and Jonathan H. Wright

NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulate
discussion and critical comment. References in publications to International Finance Discussion Papers
(other than an acknowledgment that the writer has had access to unpublished material) should be cleared
with the author or authors. Recent IFDPs are available on the Web at www.federalreserve.gov/pubs/ifdp/.
IDENTIFYING VARS BASED ON HIGH FREQUENCY FUTURES DATA

Jon Faust, Eric Swanson and Jonathan H. Wright*

Abstract: Using the prices of federal funds futures contracts, we measure the impact of the surprise
component of Federal Reserve policy decisions on the expected future trajectory of interest rates. We
show how this information can be used to identify the effects of a monetary policy shock in a standard
monetary policy VAR. This constitutes an alternative approach to identification that is quite different,
and, we would argue, more plausible, than the conventional short-run restrictions. We find that the usual
recursive identification of the model is rejected, but we nevertheless agree with the literature's conclusion
that only a small fraction of the variance of output can be attributed to monetary policy shocks.

*
Board of Governors of the Federal Reserve System. We are grateful to Graham Elliott, Jim Hamilton,
Andy Levin, Jennifer Roush and Carl Walsh for helpful comments. We are grateful to Shing-Yi Wang
for superlative research assistance and to Charles Evans for providing us with his commodity price data.
The views in this paper are solely the responsibility of the authors and should not be interpreted as
reflecting the views of the Board of Governors of the Federal Reserve System or of any person associated
with the Federal Reserve System.
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Fig. 1: Target surprise and futures rate changes (basis points)
-32 10 -31 20 -32 21
14.4667

target surprise

-36.3448
10

t+1

-32
27

t+2

-32
20

t+3

-31
25

t+4

-33
21

t+5

-32
-36.3448 14.4667 -32 27 -33 25
Fig.2: Estimated Impulse Responses and Bootstrap Intervals in CEE Identification
FF on FF FF on Y FF on P
0.4 0.1 0.1

0.35 0.05 0.05

0.3 0 0

0.25 −0.05 −0.05

0.2 −0.1 −0.1

0.15 −0.15 −0.15

0.1 −0.2 −0.2

0.05 −0.25 −0.25

0 −0.3 −0.3

−0.05 −0.35 −0.35

−0.1 −0.4 −0.4
0 12 24 36 48 60 0 12 24 36 48 60 0 12 24 36 48 60

FF on PCOM FF on NBRD FF on TR
0.1 0.5 0.5

0.08

0.06

0.04
0 0
0.02

0

−0.02
−0.5 −0.5
−0.04

−0.06

−0.08

−0.1 −1 −1
0 12 24 36 48 60 0 12 24 36 48 60 0 12 24 36 48 60
Fig. 3: Confidence Intervals for Impulse Response of Monetary Policy Shock in New Identification − fixed θ

Effect on FF Effect on Y
0.5 1

0.5

0
0

−0.5
−0.5

−1

−1 −1.5
0 12 24 36 48 60 0 12 24 36 48 60

Effect on P
0

−0.2

−0.4

−0.6

−0.8

−1

−1.2

−1.4

−1.6

−1.8

−2
0 12 24 36 48 60
Fig. 4: Confidence Intervals for Impulse Response of Monetary Policy Shock in New Identification − uncertain θ

Effect on FF Effect on Y
0.5 2

1.5

1

0
0.5

0

−0.5
−0.5

−1

−1.5

−1 −2
0 12 24 36 48 60 0 12 24 36 48 60

Effect on P
1

0.5

0

−0.5

−1

−1.5

−2

−2.5

−3
0 12 24 36 48 60