Does Curvature Enhance Forecasting?

36 Pages Posted: 14 Mar 2018

See all articles by Caio Almeida

Caio Almeida

Getulio Vargas Foundation ; Princeton University

Braz Pereira Gomes Filho Romeu

Government of the Federative Republic of Brazil - Central Bank of Brazil

Luis Leite Andre

Government of the Federative Republic of Brazil - Central Bank of Brazil

Axel Simonsen

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças

Jose Vicente

Government of the Federative Republic of Brazil - Central Bank of Brazil; Ibmec, Rio de Janeiro - IBMEC Business School

Multiple version iconThere are 2 versions of this paper

Date Written: November 19, 2008

Abstract

In this paper, we analyze the importance of curvature term structure movements on forecasts of interest rate means. An extension of the exponential three-factor Diebold and Li (2006) model is proposed, where a fourth factor captures a second type of curvature. The new factor increases model ability to generate more volatile and non-linear yield curves, leading to a significant improvement of forecasting ability, in special for short-term maturities. A forecasting experiment adopting Brazilian term structure data on Interbank Deposits (IDs) generates statistically significant lower bias and Root Mean Square Errors (RMSE) for the suggested model, for most examined maturities, under three different forecasting horizons. Consistent with recent empirical analysis of bond risk premium, when a second curvature is included, despite explaining only a small portion of interest rate variability, it changes the structure of model risk premium leading to better predictions of bond excess returns.

Keywords: Parametric Term Structure Models, Principal Components, Vector Autoregressive Models, Interest Rate Mean Forecasting

Suggested Citation

Almeida, Caio and Romeu, Braz Pereira Gomes Filho and Andre, Luis Leite and Simonsen, Axel and Vicente, Jose, Does Curvature Enhance Forecasting? (November 19, 2008). Available at SSRN: https://ssrn.com/abstract=3139714 or http://dx.doi.org/10.2139/ssrn.3139714

Caio Almeida (Contact Author)

Getulio Vargas Foundation ( email )

Praia de Botafogo 190, 11o andar
Botafogo
Rio de Janeiro, Rio de Janeiro 22250-900
Brazil
5521-37995827 (Phone)
5521-2553-8821 (Fax)

HOME PAGE: http://www.fgv.br/professor/calmeida/

Princeton University ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States

Braz Pereira Gomes Filho Romeu

Government of the Federative Republic of Brazil - Central Bank of Brazil ( email )

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distr. Federal 70074-900
Brazil

Luis Leite Andre

Government of the Federative Republic of Brazil - Central Bank of Brazil ( email )

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distr. Federal 70074-900
Brazil

Axel Simonsen

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças ( email )

Praia de Botafogo 190/1125, CEP
Rio de Janeiro RJ 22253-900
Brazil

Jose Vicente

Government of the Federative Republic of Brazil - Central Bank of Brazil

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distr. Federal 70074-900
Brazil

Ibmec, Rio de Janeiro - IBMEC Business School

SCN Quadra 2, Bloco A, 2nd. floor
Ed. Corporate Financial Center
Brasília, 707712-900
Brazil

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