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

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  • Andrea Carriero
  • Raffaella Giacomini

    ()
    (Department of Economics - University College 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.

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Bibliographic Info

Paper provided by HAL in its series Post-Print with number peer-00844809.

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Date of creation: 16 Jul 2011
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Publication status: Published, Journal of Econometrics, 2011, 164, 1, 21
Handle: RePEc:hal:journl:peer-00844809

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Related research

Keywords: C52; C53; E43; E47; Forecast combination; Encompassing; Loss functions; Instability; Affine term structure models;

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Citations

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Cited by:
  1. Andrea Carriero & George Kapetanios & Massimiliano Marcellino, 2010. "Forecasting Government Bond Yields with Large Bayesian VARs," Working Papers, Queen Mary, University of London, School of Economics and Finance 662, Queen Mary, University of London, School of Economics and Finance.
  2. Giacomini, Raffaella & Ragusa, Giuseppe, 2011. "Incorporating theoretical restrictions into forecasting by projection methods," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8604, C.E.P.R. Discussion Papers.
  3. Carriero, Andrea & Kapetanios, George & Marcellino, Massimiliano, 2012. "Forecasting government bond yields with large Bayesian vector autoregressions," Journal of Banking & Finance, Elsevier, Elsevier, vol. 36(7), pages 2026-2047.
  4. Andrea Bastianin & Marzio Galeotti & Matteo Manera, 2014. "Forecasting the Oil-gasoline Price Relationship: Should We Care about the Rockets and the Feathers?," Working Papers, Fondazione Eni Enrico Mattei 2014.21, Fondazione Eni Enrico Mattei.
  5. Caio Almeida & Axel Simonsen & José Vicente, 2012. "Forecasting Bond Yields with Segmented Term Structure Models," Working Papers Series, Central Bank of Brazil, Research Department 288, Central Bank of Brazil, Research Department.

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