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Forecasting the Interest-rate Term Structure: Using the Model of Fong & Vasicek, the Extended Kalman Filter and the Bollinger Bands

21 Pages Posted: 12 Mar 2005  

Pierre Rostan

Audencia - Nantes Ecole de Management

Raymond Théoret

University of Quebec at Montreal (UQAM) - Faculty of Management (ESG)

Abdeljalil El Moussadek

University of Quebec at Montreal (UQAM) - Faculty of Management (ESG)

Abstract

In this paper, we consider the issue of forecasting the interest-rate term structure and we present a solution. We apply the Extended Kalman Filter (EKF) to the Fong & Vasicek model to deal with the issue of computing the hidden stochastic volatility. We also introduce Bollinger bands as a variance reduction technique used to improve the Monte Carlo simulation performance. Our results suggest that the forecasting technique using the unobservable component approach (EFK) to obtain values of the stochastic volatility is superior to another stochastic volatility model such as GARCH (1,1). In addition, the performance is improved when we introduce Bollinger bands.

Keywords: Term structure of interest rate, Extended Kalman Filter, Monte Carlo simulation, Root Mean Square Error, forecasting, stochastic volatility, Bollinger bands, Fong and Vasicek

JEL Classification: C15, C63, G13

Suggested Citation

Rostan, Pierre and Théoret, Raymond and El Moussadek, Abdeljalil, Forecasting the Interest-rate Term Structure: Using the Model of Fong & Vasicek, the Extended Kalman Filter and the Bollinger Bands. Available at SSRN: https://ssrn.com/abstract=671581 or http://dx.doi.org/10.2139/ssrn.671581

Pierre Rostan (Contact Author)

Audencia - Nantes Ecole de Management ( email )

44312 Nantes Cedex 3, Cedex 3
France

Raymond Théoret

University of Quebec at Montreal (UQAM) - Faculty of Management (ESG) ( email )

Case postale 8888
Succursale Centre-ville
Montreal, Quebec H3C 3P8
Canada

Abdeljalil El Moussadek

University of Quebec at Montreal (UQAM) - Faculty of Management (ESG) ( email )

Case postale 8888
Succursale Centre-ville
Montreal, Quebec H3C 3P8
Canada

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