The Effects of Conventional and Unconventional Monetary Policy on Forecasting the Yield Curve

46 Pages Posted: 8 May 2019 Last revised: 13 Jan 2020

See all articles by Yunjong Eo

Yunjong Eo

Department of Economics, Korea University

Kyu H. Kang

Korea University

Date Written: November 13, 2019

Abstract

We investigate how conventional and unconventional monetary policies affect the dynamics of the yield curve by assessing the performance of individual yield curve models and their mixtures. Out-of-sample forecasts for U.S. bond yields show that the arbitrage-free Nelson-Siegel model and its mixtures with other models perform well in the period of conventional monetary policy, whereas the random walk model outperforms all the other models in the period of unconventional monetary policy. The diminished role of the no-arbitrage restriction in forecasting the yield curve since 2009 can be attributed to unconventional monetary policy, which resulted in low correlations between short- and long-term bond yields and little variation in the short-term rates. During the period of the maturity extension program in 2011--2012, the superiority of the random walk forecasts is more pronounced, reinforcing our finding that the monetary policy framework affects yield curve forecast accuracy.

Keywords: Quantitative Easing; Operation Twist; Dynamic Nelson-Siegel Model; Arbitrage-free Ferm Structure Model; Random Walk Model; Markov-switching Mixture

JEL Classification: C11; E43; E47; E52; G12

Suggested Citation

Eo, Yunjong and Kang, Kyu H., The Effects of Conventional and Unconventional Monetary Policy on Forecasting the Yield Curve (November 13, 2019). Available at SSRN: https://ssrn.com/abstract=3369352 or http://dx.doi.org/10.2139/ssrn.3369352

Yunjong Eo (Contact Author)

Department of Economics, Korea University ( email )

1 Anam-dong 5 ka
Seoul, 136-701
Korea, Republic of (South Korea)

Kyu H. Kang

Korea University ( email )

1 Anam-dong 5 ka
Seoul, 136-701

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