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How useful are no-arbitrage restrictions for forecasting the term structure of interest rates?

Author

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  • Andrea Carriero
  • Raffaella Giacomini

    (Department of Economics - UCL - University College of London [London])

Abstract

We develop a general framework for analyzing the usefulness of imposing parameter restrictions on a forecasting model. We propose a measure of the usefulness of the restrictions that depends on the forecaster's loss function and that could be time varying. We show how to conduct inference about this measure. The application of our methodology to analyzing the usefulness of no-arbitrage restrictions for forecasting the term structure of interest rates reveals that: (1) the restrictions have become less useful over time; (2) when using a statistical measure of accuracy, the restrictions are a useful way to reduce parameter estimation uncertainty, but are dominated by restrictions that do the same without using any theory; (3) when using an economic measure of accuracy, the no-arbitrage restrictions are no longer dominated by atheoretical restrictions, but for this to be true it is important that the restrictions incorporate a time-varying risk premium.

Suggested Citation

  • Andrea Carriero & Raffaella Giacomini, 2011. "How useful are no-arbitrage restrictions for forecasting the term structure of interest rates?," Post-Print hal-00844809, HAL.
    • Handle: RePEc:hal:journl:hal-00844809
    DOI: 10.1016/j.jeconom.2011.02.010
    Note: View the original document on HAL open archive server: https://hal.science/hal-00844809
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    More about this item

    Keywords

    C52; C53; E43; E47; Forecast combination; Encompassing; Loss functions; Instability; Affine term structure models;
    All these keywords.

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications

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