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The forecasting power of international yield curve linkages

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Author Info
Michele Modugno () (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
Kleopatra Nikolaou () (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
Abstract

This paper investigates whether information from foreign yield curves helps forecast domestic yield curves out-of-sample. A nested methodology to forecast yield curves in domestic and international settings is applied on three major countries (the US, Germany and the UK). This novel methodology is based on dynamic factor models, the EM algorithm and the Kalman lter. The domestic model is compared vis-á-vis an international one, where information from foreign yield curves is allowed to enrich the information set of the domestic yield curve. The results have interesting and original implications. They reveal clear international dependency patterns, strong enough to improve forecasts of Germany and to a lesser extent UK. The US yield curve exhibits a more independent behaviour. In this way, the paper also generalizes anecdotal evidence on international interest rate linkages to the whole yield curve. JEL Classification: F31.

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Paper provided by European Central Bank in its series Working Paper Series with number 1044.

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Length: 30 pages
Date of creation: Apr 2009
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Handle: RePEc:ecb:ecbwps:20091044

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Related research
Keywords: Yield curve forecast; Dynamic factor model; EM algorithm; International linkages.;

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  5. Matteo Ciccarelli & Benoît Mojon, 2005. "Global inflation," Working Paper Series 537, European Central Bank. [Downloadable!]
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  6. Wang, Zijun & Yang, Jian & Li, Qi, 2007. "Interest rate linkages in the Eurocurrency market: Contemporaneous and out-of-sample Granger causality tests," Journal of International Money and Finance, Elsevier, vol. 26(1), pages 86-103, February. [Downloadable!] (restricted)
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  8. Frankel, Jeffrey & Schmukler, Sergio L. & Serven, Luis, 2004. "Global transmission of interest rates: monetary independence and currency regime," Journal of International Money and Finance, Elsevier, vol. 23(5), pages 701-733, September. [Downloadable!] (restricted)
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  9. Ansgar Belke, 2002. "Does the ECB Follow the FED?," Diskussionspapiere aus dem Institut für Volkswirtschaftslehre der Universität Hohenheim 211/2002, Department of Economics, University of Hohenheim, Germany.
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  11. Perignon, Christophe & Smith, Daniel R. & Villa, Christophe, 2007. "Why common factors in international bond returns are not so common," Journal of International Money and Finance, Elsevier, vol. 26(2), pages 284-304, March. [Downloadable!] (restricted)
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  14. Hashmi, Aamir R. & Tay, Anthony S., 2007. "Global regional sources of risk in equity markets: Evidence from factor models with time-varying conditional skewness," Journal of International Money and Finance, Elsevier, vol. 26(3), pages 430-453, April. [Downloadable!] (restricted)
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