Forecasting the Yield Curve in a Data-Rich Environment: A No-Arbitrage Factor-Augmented VAR Approach

41 Pages Posted: 6 Mar 2005

See all articles by Emanuel Moench

Emanuel Moench

Deutsche Bundesbank; Goethe University Frankfurt - Department of Money and Macroeconomics

Date Written: March 2006

Abstract

This paper suggests a term structure model which parsimoniously exploits a broad macroeconomic information set. The model does not incorporate latent yield curve factors, but instead uses the common components of a large number of macroeconomic variables and the short rate as explanatory factors. Precisely, an affine term structure model with parameter restrictions implied by no-arbitrage is added to a Factor-Augmented Vector Autoregression (FAVAR). The model is found to strongly outperform different benchmark models in out-of-sample yield forecasts, reducing root mean squared forecast errors relative to the random walk up to 50% for short and around 20% for long maturities.

Keywords: Affine term structure models, Yield curve, dynamic factor models, FAVAR

JEL Classification: C13, C32, E43, E44, E52

Suggested Citation

Moench, Emanuel, Forecasting the Yield Curve in a Data-Rich Environment: A No-Arbitrage Factor-Augmented VAR Approach (March 2006). EFA 2005 Moscow Meetings, ECB Working Paper No. 544, AFA 2007 Chicago Meetings Paper, Available at SSRN: https://ssrn.com/abstract=676909

Emanuel Moench (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany
+49 69 95662312 (Phone)

HOME PAGE: http://https://www.bundesbank.de/en/emanuel-moench

Goethe University Frankfurt - Department of Money and Macroeconomics ( email )

Germany

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