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Forecasting the U.S. Term Structure of Interest Rates using a Macroeconomic Smooth Dynamic Factor Model

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  • Siem Jan Koopman

    ()
    (VU University Amsterdam)

  • Michel van der Wel

    ()
    (Erasmus University Rotterdam)

Abstract

We extend the class of dynamic factor yield curve models for the inclusion of macro-economic factors. We benefit from recent developments in the dynamic factor literature for extracting the common factors from a large panel of macroeconomic series and for estimating the parameters in the model. We include these factors into a dynamic factor model for the yield curve, in which we model the salient structure of the yield curve by imposing smoothness restrictions on the yield factor loadings via cubic spline functions. We carry out a likelihood-based analysis in which we jointly consider a factor model for the yield curve, a factor model for the macroeconomic series, and their dynamic interactions with the latent dynamic factors. We illustrate the methodology by forecasting the U.S. term structure of interest rates. For this empirical study we use a monthly time series panel of unsmoothed Fama-Bliss zero yields for treasuries of different maturities between 1970 and 2009, which we combine with a macro panel of 110 series over the same sample period. We show that the relation between the macroeconomic factors and yield curve data has an intuitive interpretation, and that there is interdependence between the yield and macroeconomic factors. Finally, we perform an extensive out-of-sample forecasting study. Our main conclusion is that macroeconomic variables can lead to more accurate yield curve forecasts.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 11-063/4.

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Date of creation: 07 Apr 2011
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Handle: RePEc:dgr:uvatin:20110063

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Web page: http://www.tinbergen.nl

Related research

Keywords: Fama-Bliss data set; Kalman filter; Maximum likelihood; Yield curve;

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Cited by:
  1. Gregory R. Duffee, 2012. "Forecasting interest rates," Economics Working Paper Archive 599, The Johns Hopkins University,Department of Economics.
  2. GUO-FITOUSSI, Liang, 2013. "A Comparison of the Finite Sample Properties of Selection Rules of Factor Numbers in Large Datasets," MPRA Paper 50005, University Library of Munich, Germany.

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