Does Curvature Enhance Forecasting?
AbstractIn this paper, we analyze the importance of curvature term structure movements on forecasts of interest rate means. An extension of the exponential three-factor Diebold and Li (2006) model is proposed, where a fourth factor captures a second type of curvature. The new factor increases model ability to generate more volatile and non-linear yield curves, leading to a significant improvement of forecasting ability, in special for short-term maturities. A forecasting experiment adopting Brazilian term structure data on Interbank Deposits (IDs) generates statistically significant lower bias and Root Mean Square Errors (RMSE) for the double curvature model, for most examined maturities, under three different forecasting horizons. Consistent with recent empirical analysis of bond risk premium, when a second curvature is included, despite explaining only a small portion of interest rate variability, it changes the structure of model risk premium leading to better predictions of bond excess returns.
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Bibliographic InfoPaper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 155.
Date of creation: Dec 2007
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Other versions of this item:
- Caio Almeida & Romeu Gomes & André Leite & Axel Simonsen & José Vicente, 2009. "Does Curvature Enhance Forecasting?," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 12(08), pages 1171-1196.
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- Rodrigo Cabral & Richard Munclinger & Luiz Alves & Marco Rodriguez Waldo, 2011. "On Brazilâ€™s Term Structure: Stylized Facts and Analysis of Macroeconomic Interactions," IMF Working Papers 11/113, International Monetary Fund.
- Marco Shinobu Matsumura & Ajax Reynaldo Bello Moreira & José Valentim Machado Vicente, 2010. "Forecasting the Yield Curve with Linear Factor Models," Working Papers Series 223, Central Bank of Brazil, Research Department.
- Leite, André Luís & Filho, Romeu Braz Pereira Gomes & Vicente, José Valentim Machado, 2010. "Forecasting the yield curve: A statistical model with market survey data," International Review of Financial Analysis, Elsevier, vol. 19(2), pages 108-112, March.
- Rafael Barros de Rezende, 2008. "Giving flexibility to the Nelso-Siegel class of term structure models," Anais do XXXVI Encontro Nacional de Economia [Proceedings of the 36th Brazilian Economics Meeting] 200807211322560, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
- Joao Frois Caldeira & Guilherme Valle Moura & Marcelo Savino Portugal, 2011. "Efficient Interest Ratecurve Estimation And Forecasting In Brazil," Anais do XXXVII Encontro Nacional de Economia [Proceedings of the 37th Brazilian Economics Meeting] 133, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
- Flávio de Freitas Val & Claudio Henrique da Silveira Barbedo & Marcelo Verdini Maia, 2011. "Inflation expectation and implicit inflation: does market research provide accurate measures?," Brazilian Business Review, Fucape Business School, vol. 8(3), pages 83-100, July.
- Caio Almeida & Axel Simonsen & José Vicente, 2012. "Forecasting Bond Yields with Segmented Term Structure Models," Working Papers Series 288, Central Bank of Brazil, Research Department.
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