Modeling and Prediciton of T-Bill Rate

In this paper, we examine two hypotheses approaches to determine the short-term “risk-free” rate (e.g., 3-month Treasury bill) and use the better one to predict the T-bill rate of December 2010. The first model uses the implied three-month forward rate of interest computed by pure expectations as the independent variable, and the second one is to develop a simple regression econometric model using initial claims for unemployment insurance as the explanatory variable to explain the interest rate. In order to get a comparatively precise result, we analyze the two models over two most recent business cycles.

The first cycle is from 1992 to 2001. In this period, the United States was still experiencing economic depression at the beginning of 90s due to the accumulated economic depression during the 80s. Then with the rapid development of high-technology industry, the economy of United States began to expand from 1995 and reached the peak in 1999 and 2000. In order to avoid inflation, the Federal increased the interest rates. In 2001, when economic growth rate fell to zero, the United States entered into another economy recession due to the burst of tech bubble. To expand the economy, the Federal decreased interest rates.

Figure 1. 3 month t-bill rate trend, 1995 to 2008

According to the graph above, we can find that the T-bill rate had experienced great fluctuation during the second cycle from 2002 to 2010. At the beginning of this period, the t-bill rate displayed a roughly continuous decline as the consequence of the recession in 2001. To address this situation, the government adopted the proactive fiscal policy and prudent monetary policy to expand domestic demand and curb deflation while the Federal Reserve took action to lower the interest rate. At lower interest rates, firms will increase demand for capital, capital asset prices increase and firms producing new capital goods increase quantity supplied. In 2004, the economy had entered one rapid growth...