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Nearest-Neighbor Forecasts of U.S. Interest Rates

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  • John Barkoulas

    (University of Tennessee)

  • Christopher F. Baum

    ()
    (Boston College)

  • Atreya Chakraborty

    (Brattle Group)

Abstract

We employ a nonlinear, nonparametric method to model the stochastic behavior of changes in several short and long term U.S. interest rates. We apply a nonlinear autoregression to the series using the locally weighted regression (LWR) estimation method, a nearest-neighbor method, and evaluate the forecasting performance with a measure of root mean square error (RMSE). We compare the forecast performance of the nonparametric fit to the performance of two benchmark linear models: an autoregressive model and a random-walk-with-drift model. The nonparametric model exhibits greater out-of-sample forecast accuracy than that of the linear predictors for most U.S. interest rate series. The improvements in forecast accuracy are statistically significant and robust. This evidence establishes the presence of significant nonlinear mean predictability in U.S. interest rates, as well as the usefulness of the LWR method as a modeling strategy for these benchmark series.

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File URL: http://fmwww.bc.edu/EC-P/wp313.pdf
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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 313..

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Length: 26 pages
Date of creation: 01 Feb 1996
Date of revision: 01 Apr 2003
Publication status: published in International Journal of Banking and Finance, 1:1, 119-135, 2003.
Handle: RePEc:boc:bocoec:313

Note: Previously circulated as "Essential Nonparametric Prediction of U.S. Interest Rates"
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Keywords: interest rate forecasts; locally weighted regression;

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References

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Cited by:
  1. Baghestani, Hamid, 2006. "An evaluation of the professional forecasts of U.S. long-term interest rates," Review of Financial Economics, Elsevier, vol. 15(2), pages 177-191.
  2. Marcos Álvarez-Díaz & Shawkat Hammoudeh & Rangan Gupta, 2013. "Detecting Predictable Non-linear Dynamics in Dow Jones Industrial Average and Dow Jones Islamic Market Indices using Nonparametric Regressions," Working Papers 201385, University of Pretoria, Department of Economics.

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