On the Relationship Between the Very Short Forward and the Spot Interest Rate

This paper revisits the relationship between the forward and the spot interest rate. In contrast to much of the literature we investigate at the very short maturities. The "tomorrow next" rate is the forward interest rate, but has the same maturity as the overnight rate. We estimate an asymmetry in predictability of the very short forward interest rate across different markets. This asymmetry depends on whether the forward rate is greater or less than the current spot rate. To explain this we develop a theoretical framework that incorporates institutional settings, based on interviews with Japanese market participants, such as a penalty for overdrafts, and the inability of securities firms to procure funds.