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Forecasting interest rate swap spreads using domestic and international risk factors: evidence from linear and non-linear models

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  • Ilias Lekkos

    (Department of Economic Analysis and Forecasting, Eurobank EFG, Athens, Greece)

  • Costas Milas

    (School of Economic and Management Studies, Keele University, Keele, UK)

  • Theodore Panagiotidis

    (Department of Economics, Loughborough University, Loughborough, UK)

Abstract

This paper explores the ability of factor models to predict the dynamics of US and UK interest rate swap spreads within a linear and a non-linear framework. We reject linearity for the US and UK swap spreads in favour of a regime-switching smooth transition vector autoregressive (STVAR) model, where the switching between regimes is controlled by the slope of the US term structure of interest rates. We compare the ability of the STVAR model to predict swap spreads with that of a non-linear nearest-neighbours model as well as that of linear AR and VAR models. We find some evidence that the non-linear models predict better than the linear ones. At short horizons, the nearest-neighbours (NN) model predicts better than the STVAR model US swap spreads in periods of increasing risk conditions and UK swap spreads in periods of decreasing risk conditions. At long horizons, the STVAR model increases its forecasting ability over the linear models, whereas the NN model does not outperform the rest of the models. Copyright © 2007 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/for.1048
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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Forecasting.

Volume (Year): 26 (2007)
Issue (Month): 8 ()
Pages: 601-619

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Handle: RePEc:jof:jforec:v:26:y:2007:i:8:p:601-619

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Web page: http://www3.interscience.wiley.com/cgi-bin/jhome/2966

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  1. Bajo-Rubio, Oscar & Sosvilla-Rivero, Simon & Fernandez-Rodriguez, Fernando, 2001. "Asymmetry in the EMS: New evidence based on non-linear forecasts," European Economic Review, Elsevier, vol. 45(3), pages 451-473, March.
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Cited by:
  1. Chung, Hon-Lun & Chan, Wai-Sum, 2010. "Impact of credit spreads, monetary policy and convergence trading on swap spreads," International Review of Financial Analysis, Elsevier, vol. 19(2), pages 118-126, March.

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