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Forecasting the yield curve in a data-rich environment: a no-arbitrage factor-augmented VAR approach

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  • Mönch, Emanuel

Abstract

This paper suggests a term structure model which parsimoniously exploits a broad macroeconomic information set. The model does not incorporate latent yield curve factors, but instead uses the common components of a large number of macroeconomic variables and the short rate as explanatory factors. Precisely, an affine term structure model with parameter restrictions implied by no-arbitrage is added to a Factor-Augmented Vector Autoregression (FAVAR). The model is found to strongly outperform different benchmark models in out-of-sample yield forecasts, reducing root mean squared forecast errors relative to the random walk up to 50% for short and around 20% for long maturities. JEL Classification: C13, C32, E43, E44, E52

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0544.

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Date of creation: Nov 2005
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Handle: RePEc:ecb:ecbwps:20050544

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Keywords: Affine term structure models; Dynamic Factor Models; FAVAR; yield curve;

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