Term Structure Forecasting Using Macro Factors and Forecast Combination

54 Pages Posted: 7 Apr 2010

See all articles by Michiel De Pooter

Michiel De Pooter

Board of Governors of the Federal Reserve System

Francesco Ravazzolo

Free University of Bozen-Bolzano - Faculty of Economics and Management; BI Norwegian Business School

Dick J. C. van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute; ERIM

Date Written: March 25, 2010

Abstract

We examine the importance of incorporating macroeconomic information and, in particular, accounting for model uncertainty when forecasting the term structure of U.S. interest rates. We start off by analyzing and comparing the forecast performance of several individual term structure models. Our results confirm and extend results found in previous literature that adding macroeconomic information, through factors extracted from a large number of individual series, tends to improve interest rate forecasts. We then show, however, that the predictive power of individual models varies over time significantly. Models with macro factors are the more accurate in and around recession periods. Models without macro factors do particularly well in low-volatility subperiods such as the late 1990s. We demonstrate that this problem of model uncertainty can be mitigated by combining individual model forecasts. Combining forecasts leads to encouraging gains in predictability, especially for longer-dated maturities, and importantly, these gains are consistent over time.

Keywords: Term structure of interest rates, Nelson-Siegel model, affine term structure model, macro factors, forecast combination, model confidence set

JEL Classification: C5, C11, C32, E43, E47

Suggested Citation

De Pooter, Michiel and Ravazzolo, Francesco and van Dijk, Dick J.C., Term Structure Forecasting Using Macro Factors and Forecast Combination (March 25, 2010). FRB International Finance Discussion Paper No. 993; Norges Bank Working Paper 2010/01. Available at SSRN: https://ssrn.com/abstract=1585174 or http://dx.doi.org/10.2139/ssrn.1585174

Michiel De Pooter (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Francesco Ravazzolo

Free University of Bozen-Bolzano - Faculty of Economics and Management ( email )

Via Sernesi 1
39100 Bozen-Bolzano (BZ), Bozen 39100
Italy

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

HOME PAGE: http://www.francescoravazzolo.com/

Dick J.C. Van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute

P.O. Box 1738
3000 DR Rotterdam
Netherlands

ERIM ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 1263 (Phone)
+31 10 4089162 (Fax)

HOME PAGE: http://people.few.eur.nl/djvandijk

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