Term Structure Forecasting: No-Arbitrage Restrictions versus Large Information Set
Carlo A. Favero
Bocconi University - Department of Finance; Centre for Economic Policy Research (CEPR)
Xiamen University - The Wang Yanan Institute for Studies in Economics (WISE)
University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER)
Paolo Baffi Centre Research Paper No. 2009-44
This paper addresses the issue of forecasting the term structure. We provide a unified state-space modelling framework that encompasses different existing discrete-time yield curve models. Within such framework we analyze the impact of two modelling choices, namely the imposition of no-arbitrage restrictions and the size of the information set used to extract factors, on the forecasting performance. Using US yield curve data, we find that both no-arbitrage and large info help in forecasting but no model uniformly dominates the other. No-arbitrage models are more useful at shorter horizon for shorter maturities. Large information sets are more useful at longer horizons and longer maturities. We also find evidence for a significant feedback from yield curve models to macroeconomic variables that could be exploited for macroeconomic forecasting.
Number of Pages in PDF File: 48
Keywords: Yield curve, term structure of interest rates, forecasting
JEL Classification: C33, C53, E43, E44working papers series
Date posted: May 4, 2009
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