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When calculating the probability of a certain target rate specified by the Fed at an FOMC release, I’ve generally read that it is typical to use Fed Funds Futures as proxies. I can find data on this on the CME’s website. Bloomberg also has functionality to perform this calculation, but they use OIS’s to estimate the probability. When comparing the two methods for a given FOMC meeting date, they give fairly similar, but not super close answers, say in the range of 5%-10% max difference. What is the theoretical basis of using OIS’s is, as opposed to Fed Funds Futures? Is one more correct? Any source material is appreciated.

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    $\begingroup$ it is not clear to me why futures are used here. I've seen something similar, but use options to imply the rate's probability distribution. Regarding OIS and Fed fund Future, one is compounded rate and the other is an average rate, but the underlying rate are both the overnight rate $\endgroup$ – PeacePanda Nov 27 '19 at 22:28
  • $\begingroup$ Here’s a good link explaining the use of Fed Funds Futures for rate probabilities. I imagine OIS logic is similar, but don’t know what market dynamics/conditions make the resulting probabilities different. economics-finance.org/jefe/fin/KeaslerGoffpaper.pdf $\endgroup$ – Mild_Thornberry Nov 28 '19 at 14:17
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I think you have a little misunderstanding. OIS just means the rate for fed funds. Usually people are referring to "FEDL01 Index" on Bloomberg. That's the VWAP of trades for the previous day in Fed Funds with participants lending to each-other. That's all in the past. That tells you nothing about the future.

The Fed Funds futures settle to the average over the reference month for FEDL01. That's forward looking. If you are looking at what the current market thinks Fed Funds will be at point X in time you have to navigate the Fed Funds futures.

I'll show you here the Fed Funds futures market right now:

Current Fed Funds futures market

And here's Bloomberg's use of these futures to calculate future rate path: enter image description here

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  • $\begingroup$ This is not quite what I was talking about. I was referencing the <WIRP> functionality in Bloomberg, but trying to make the question general enough to be answered by non-Bloomberg subscribers. I appreciate the help though! So as a Bloomberg user, I can rephrase: why does Bloomberg’s <WIRP> command calculate different probabilities than the CME’s FOMC Watch Tool? $\endgroup$ – Mild_Thornberry Nov 29 '19 at 15:08
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    $\begingroup$ Oh, I'm not familiar with the CME FOMC watch tool. But the Bloomberg methodology on WIRP is correct. The CME tool might have a day count problem. Given that we know the history of FED01L until today it's pretty provable. I've validated Bloomberg's methodology myself many times. $\endgroup$ – JoshK Dec 1 '19 at 4:40
  • $\begingroup$ That’s good enough for me! I’m still interested in why there is a difference, but for practical purposes, I wanted some confidence in choosing one or the other to follow. $\endgroup$ – Mild_Thornberry Dec 1 '19 at 17:33

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