Predicting the Term Structure of Interest Rates: Incorporating Parameter Uncertainty, Model Uncertainty and Macroeconomic Information

52 Pages Posted: 4 Mar 2007 Last revised: 4 May 2010

Michiel De Pooter

Board of Governors of the Federal Reserve System

Francesco Ravazzolo

Free University of Bolzano

Dick J. C. van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute; ERIM

Date Written: October 25, 2007

Abstract

We assess the relevance of parameter uncertainty, model uncertainty, and macroeconomic information for forecasting the term structure of interest rates. We study parameter uncertainty by comparing Bayesian inference with frequentist estimation techniques, and model uncertainty by combining forecasts from individual models. We incorporate macroeconomic information in yield curve models by extracting common factors from a large panel of macro series. Our results show that accounting for parameter uncertainty does not improve the forecast performance of individual models. The predictive accuracy of single models varies over time considerably and we demonstrate that mitigating model uncertainty by combining forecasts leads to substantial gains in predictability. Combining forecasts using a weighting method that is based on relative historical performance results in highly accurate forecasts. The gains in terms of forecast performance are substantial, especially for longer maturities, and are consistent over time. In addition, we find that adding macroeconomic factors generally is beneficial for improving out-of-sample forecasts.

Keywords: Term structure of interest rates, Nelson-Siegel model, Affine term structure model, forecast combination, Bayesian analysis

JEL Classification: C5, C11, C32, E43, E47

Suggested Citation

De Pooter, Michiel and Ravazzolo, Francesco and van Dijk, Dick J. C., Predicting the Term Structure of Interest Rates: Incorporating Parameter Uncertainty, Model Uncertainty and Macroeconomic Information (October 25, 2007). Available at SSRN: https://ssrn.com/abstract=967914 or http://dx.doi.org/10.2139/ssrn.967914

Michiel De Pooter (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Francesco Ravazzolo

Free University of Bolzano ( email )

Bolzano
Italy

Dick J.C. Van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute

P.O. Box 1738
3000 DR Rotterdam
Netherlands

ERIM ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 1263 (Phone)
+31 10 4089162 (Fax)

HOME PAGE: http://people.few.eur.nl/djvandijk

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