Analysis on the Effect of Foreign Factors on the Korean Bond market and Prediction using Two-country Nelson-Siegel Model (in Korean)

Since the foreign exchange crisis in 1997, the Korean economy has been transformed to become more exposed to global economic situation. This paper aims at empirically verifying the impact of foreign factors on the Korean bond market with two-country Nelson-Siegel model. The estimation result indicates that foreign factors, along with domestic factors, have significant effects on the yield curve of Korea. From variance decomposition analysis, it is found that the slope factor of the yield curve, which is related business cycle, is affected the most by the foreign factors. Additionally, this paper attempts to verify the predictive power of foreign factors to the future Korean spot rate. To serve its purpose, it exploits out-of-sample forecasting with data from Jan. 2006 to Dec 2010. According to the modified Diebold & Mariano test, the two-country Nelson-Siegel model has a statistically superior predictive power to the conventional Nelson-Siegel model at the 6-month-ahead prediction with less than three year maturities. In conclusion, it is necessary to have foreign factors additionally considered for effective prediction of Korean spot rates with short-term and mid-term maturity.