An Empirical Investigation of the Forward Interest Rate Term Structure

TL;DR

This paper empirically analyzes the forward interest rate term structure across five currencies, confirming a square-root law pattern and revealing a correlation with past spot trends, supported by a calibrated model.

Contribution

It extends previous research by analyzing multiple currencies and proposing a model that captures the observed effects and correlations in the forward rate curve.

Findings

Average FRC follows a square-root law related to spot volatility

Strong correlation between FRC and past spot trends

Model successfully calibrates to observed effects

Abstract

In this paper we study empirically the Forward Rate Curve (FRC) of 5 different currencies. We confirm and extend the findings of our previous investigation of the U.S. Forward Rate Curve. In particular, the average FRC follows a square-root law, with a prefactor related to the spot volatility, suggesting a Value-at-Risk like pricing. We find a striking correlation between the instantaneous FRC and the past spot trend over a certain time horizon, in agreement with the idea of an extrapolated trend effect. We present a model which can be adequately calibrated to account for these effects.