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Forecasting Interest Rates with Shifting Endpoints

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Author Info

  • Dick van Dijk

    (Erasmus University Rotterdam)

  • Siem Jan Koopman

    (VU University Amsterdam)

  • Michel van der Wel

    (Erasmus University Rotterdam, CREATES, Aarhus)

  • Jonathan H. Wright

    (Johns Hopkins University)

Abstract

Many economic studies on inflation forecasting have found favorable results when inflation is modeled as a stationary process around a slowly time-varying trend. In contrast, the existing studies on interest rate forecasting either treat yields as being stationary, without any shifting endpoints, or treat yields as a random walk process. In this study we consider the problem of forecasting the term structure of interest rates with the assumption that the yield curve is driven by factors that are stationary around a time-varying trend. We compare alternative ways of modeling the time-varying trend. We find that allowing for shifting endpoints in yield curve factors can provide gains in the out-of-sample predictive accuracy, relative to stationary and random walk benchmarks. The results are both economically and statistically significant.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 12-076/4.

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Date of creation: 19 Jul 2012
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Handle: RePEc:dgr:uvatin:20120076

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

Related research

Keywords: term structure of interest rates; forecasting; non-stationarity; survey forecasts; yield curve;

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References

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  1. Albert Lee Chun, 2005. "Expectations, Bond Yields and Monetary Policy," Discussion Papers, Stanford Institute for Economic Policy Research 04-023, Stanford Institute for Economic Policy Research, revised Nov 2010.
  2. Clements,Michael & Hendry,David, 1998. "Forecasting Economic Time Series," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521632423.
  3. West, Kenneth D., 2006. "Forecast Evaluation," Handbook of Economic Forecasting, Elsevier, Elsevier.
  4. Michiel de Pooter & Francesco Ravazzolo & Dick van Dijk, 2010. "Term structure forecasting using macro factors and forecast combination," Working Paper, Norges Bank 2010/01, Norges Bank.
  5. Diebold, Francis X. & Li, Canlin, 2006. "Forecasting the term structure of government bond yields," Journal of Econometrics, Elsevier, Elsevier, vol. 130(2), pages 337-364, February.
  6. Orphanides, Athanasios & Wei, Min, 2012. "Evolving macroeconomic perceptions and the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 36(2), pages 239-254.
  7. Philipp Illeditsch & Michael Gallmeyer & Christian Heyerdahl-Larsen & Paul Ehling, 2009. "Beliefs about Inflation and the Term Structure of Interest Rates," 2009 Meeting Papers, Society for Economic Dynamics 1223, Society for Economic Dynamics.
  8. Francis X. Diebold & Glenn D. Rudebusch & S. Boragan Aruoba, 2004. "The Macroeconomy and the Yield Curve: A Dynamic Latent Factor Approach," NBER Working Papers 10616, National Bureau of Economic Research, Inc.
  9. Bacchetta, Philippe & Mertens, Elmar & van Wincoop, Eric, 2009. "Predictability in financial markets: What do survey expectations tell us?," Journal of International Money and Finance, Elsevier, Elsevier, vol. 28(3), pages 406-426, April.
  10. Michiel De Pooter, 2007. "Examining the Nelson-Siegel Class of Term Structure Models," Tinbergen Institute Discussion Papers, Tinbergen Institute 07-043/4, Tinbergen Institute.
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