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Forecasting in efficient bond markets: Do experts know better?

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  • Baghestani, Hamid
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    Abstract

    Term structure theory suggests that bond rates in efficient markets approximately follow a random walk. We show that the random walk forecasts of 10-year U.S. Treasury and Moody's Aaa corporate bond rates for 1988-2005 are generally unbiased. Blue Chip forecasts, however, are both biased and inferior to random walk forecasts. Both models produce unbiased forecasts of the default spread, with the random walk again outperforming the Blue Chip. In addition, Blue Chip fails to accurately predict directional change. Emphasizing that the success of the random walk model is theoretically expected, we discuss why experts fail to beat random walk predictions.

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    Bibliographic Info

    Article provided by Elsevier in its journal International Review of Economics & Finance.

    Volume (Year): 18 (2009)
    Issue (Month): 4 (October)
    Pages: 624-630

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    Handle: RePEc:eee:reveco:v:18:y:2009:i:4:p:624-630

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    Web page: http://www.elsevier.com/locate/inca/620165

    Related research

    Keywords: Blue Chip Term structure Bond market efficiency Rationality Directional accuracy;

    References

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    1. Pesando, James E., 1981. "On forecasting interest rates : An efficient markets perspective," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 305-318.
    2. Scharfstein, David. & Stein, Jeremy C., 1988. "Herd behavior and investment," Working papers WP 2062-88., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    3. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
    4. Fair, Ray C & Shiller, Robert J, 1990. "Comparing Information in Forecasts from Econometric Models," American Economic Review, American Economic Association, vol. 80(3), pages 375-89, June.
    5. Batchelor, Roy & Dua, Pami, 1991. "Blue Chip Rationality Tests," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(4), pages 692-705, November.
    6. Yvon Fauvel & Alain Paquet & Christian Zimmermann, 1999. "A Survey on Interest Rate Forecasting," Cahiers de recherche CREFE / CREFE Working Papers 87, CREFE, Université du Québec à Montréal.
    7. Greer, Mark, 2003. "Directional accuracy tests of long-term interest rate forecasts," International Journal of Forecasting, Elsevier, vol. 19(2), pages 291-298.
    8. Joutz, Fred & Stekler, H. O., 2000. "An evaluation of the predictions of the Federal Reserve," International Journal of Forecasting, Elsevier, vol. 16(1), pages 17-38.
    9. Pesando, James E, 1979. "On the Random Walk Characteristics of Short- and Long-Term Interest Rates in an Efficient Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(4), pages 457-66, November.
    10. David H. Romer & Christina D. Romer, 2000. "Federal Reserve Information and the Behavior of Interest Rates," American Economic Review, American Economic Association, vol. 90(3), pages 429-457, June.
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