Estimating Term Structure of Interest Rates: Neural Network vs One Factor Parametric Models

U of Sfax, Business and Economics Working Paper

13 Pages Posted: 12 Jun 2002

See all articles by Fathi Abid

Fathi Abid

University of Sfax, Faculty of Economic and Management Sciences, Probability & Statistics Laboratory

Mona Ben Salah

University of Sfax - Faculty of Economics and Management (FSEGS)

Date Written: May 2002

Abstract

The aim of this paper is twofold; first we concentrate on the work of Vasicek (1977) and Cox, Ingersoll and Ross (1985). We examine and test empirically each model and discuss its performance in predicting the term structure of interest rates using a parametric estimating approach GMM (Generalized Moments Method). Second we estimate the term structure of interest rate dynamics using a nonparametric approach ANN (Artificial Neural Network). Two neural network models are performed. The first model uses spreads between interest rates of 10 different maturities as the only explanatory variable of interest rate changes. The second model introduces two factors, spreads and interest rates' levels. Using historical U.S. Treasury bill rates and Treasury bond yields, we compare the ability of each model to predict the term structure of interest rates. Data are daily and cover the period from 3 January 1995 to 29 December 2000. Results suggest that, neural network; Vasicek (1977) and Cox, Ingersoll and Ross (1985) models generate different yield curves. Neural network models outperform the parametric standard models. The most successful forecast is obtained with two factors neural network model.

Keywords: Neural Network, Interest Rate Term Structure, Parametric models, GMM

Suggested Citation

Abid, Fathi and Ben Salah, Mona, Estimating Term Structure of Interest Rates: Neural Network vs One Factor Parametric Models (May 2002). U of Sfax, Business and Economics Working Paper. Available at SSRN: https://ssrn.com/abstract=313561 or http://dx.doi.org/10.2139/ssrn.313561

Fathi Abid (Contact Author)

University of Sfax, Faculty of Economic and Management Sciences, Probability & Statistics Laboratory ( email )

Road of Airport, Km 4
Sfax, sfax 3018
Tunisia
+216 7427 9154 (Phone)

Mona Ben Salah

University of Sfax - Faculty of Economics and Management (FSEGS) ( email )

Road of Airport, Km 4
Sfax, sfax 3018
Tunisia

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