This paper addresses the issue of forecasting the term structure. We provide a unified state-space modelling framework that encompasses different existing discrete-time yield curve models. Within such framework we analyze the impact on forecasting performance of two crucial modelling choices, i.e. the imposition of no-arbitrage restrictions and the size of the information set used to extract factors. Using US yield curve data, we find that: a. macro factors are very useful in forecasting at medium/long forecasting horizon; b. financial factors are useful in short run forecasting; c. no-arbitrage models are effective in shrinking the dimensionality of the parameter space and, when supplemented with additional macro information, are very effective in forecasting; d. within no-arbitrage models, assuming time-varying risk price is more favourable than assuming constant risk price for medium horizon-maturity forecast when yield factors dominate the information set, and for short horizon and long maturity forecast when macro factors dominate the information set; e. however, given the complexity and the highly non-linear parameterization of no-arbitrage models, it is very difficult to exploit within this type of models the additional information offered by large macroeconomic datasets.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
6206.
Find related papers by JEL classification: C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
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Domenico Giannone & Lucrezia Reichlin & Luca Sala, .
"Monetary Policy in Real Time,"
Working Papers
284, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
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Andrew Ang & Sen Dong & Monika Piazzesi, 2005.
"No-arbitrage Taylor rules,"
Proceedings,
Federal Reserve Bank of San Francisco.
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