Term Structure Forecasting: No-Arbitrage Restrictions versus Large Information Set

48 Pages Posted: 4 May 2009

See all articles by Carlo A. Favero

Carlo A. Favero

Bocconi University - Department of Finance; Centre for Economic Policy Research (CEPR)

Linlin Niu

Xiamen University - Wang Yanan Institute for Studies in Economics (WISE); Xiamen University - School of Economics

Luca Sala

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER)

Date Written: May 2009

Abstract

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.

Keywords: Yield curve, term structure of interest rates, forecasting

JEL Classification: C33, C53, E43, E44

Suggested Citation

Favero, Carlo A. and Niu, Linlin and Sala, Luca, Term Structure Forecasting: No-Arbitrage Restrictions versus Large Information Set (May 2009). Paolo Baffi Centre Research Paper No. 2009-44. Available at SSRN: https://ssrn.com/abstract=1398649 or http://dx.doi.org/10.2139/ssrn.1398649

Carlo A. Favero (Contact Author)

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

HOME PAGE: http://www.igier.unibocconi.it\favero

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Linlin Niu

Xiamen University - Wang Yanan Institute for Studies in Economics (WISE) ( email )

A 306, Economics Building
Xiamen, Fujian 361005
China

Xiamen University - School of Economics ( email )

China

Luca Sala

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER) ( email )

Via Roentgen 1
Milan, 20136
Italy
+39 02 5836 3326 (Phone)

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