Advanced Search
MyIDEAS: Login to save this paper or follow this series

The Dynamics of Economic Functions: Modelling and Forecasting the Yield Curve

Contents:

Author Info

  • Clive G. Bowsher

    ()
    (Nuffield College, Oxford University)

  • Roland Meeks

    ()
    (Federal Reserve Bank of Dallas)

Abstract

The class of Functional Signal plus Noise (FSN) models is introduced that provides a new, general method for modelling and forecasting time series of economic functions. The underlying, continuous economic function (or `signal') is a natural cubic spline whose dynamic evolution is driven by a cointegrated vector autoregression for the ordinates (or 'y-values') at the knots of the spline. The natural cubic spline provides flexible cross-sectional fit and results in a linear, state space model. This FSN model achieves dimension reduction, provides a coherent description of the observed yield curve and its dynamics as the cross-sectional dimension N becomes large, and can feasibly be estimated and used for forecasting when N is large. The integration and cointegration properties of the model are derived. The FSN models are then applied to forecasting 36-dimensional yield curves for US Treasury bonds at the one month ahead horizon. The method consistently outperforms the Diebold and Li (2006) and random walk forecasts on the basis of both mean square forecast error criteria and economically relevant loss functions derived from the realised profits of pairs trading algorithms. The analysis also highlights in a concrete setting the dangers of attempts to infer the relative economic value of model forecasts on the basis of their associated mean square forecast errors.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.nuffield.ox.ac.uk/economics/papers/2008/w5/FSN.ECM_YCurve_Bowsher.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2008-W05.

as in new window
Length: 40 pages
Date of creation: 04 2008
Date of revision:
Handle: RePEc:nuf:econwp:0805

Contact details of provider:
Web page: http://www.nuff.ox.ac.uk/economics/

Related research

Keywords: FSN-ECM models; functional time series; term structure; forecasting interest rates; natural cubic spline; state space form.;

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Siem Jan Koopman & Marius Ooms, 2003. "Time Series Modelling of Daily Tax Revenues," Statistica Neerlandica, Netherlands Society for Statistics and Operations Research, Netherlands Society for Statistics and Operations Research, vol. 57(4), pages 439-469.
  2. Francis X. Diebold & Canlin Li, 2002. "Forecasting the Term Structure of Government Bond Yields," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 02-34, Wharton School Center for Financial Institutions, University of Pennsylvania.
  3. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, American Economic Association, vol. 77(4), pages 680-92, September.
  4. Oliver Linton & Andrew Jeffrey & Thong Nguyen, 2001. "Flexible Term Structure Estimation: Which Method is Preferred?," FMG Discussion Papers, Financial Markets Group dp385, Financial Markets Group.
  5. Koopman, S.J.M. & Shephard, N. & Doornik, J.A., 1998. "Statistical Algorithms for Models in State Space Using SsfPack 2.2," Discussion Paper, Tilburg University, Center for Economic Research 1998-141, Tilburg University, Center for Economic Research.
  6. DeRossi, G. & Harvey, A., 2006. "Time-Varying Quantiles," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 0649, Faculty of Economics, University of Cambridge.
  7. Stock, James H. & Watson, Mark W., 2006. "Forecasting with Many Predictors," Handbook of Economic Forecasting, Elsevier, Elsevier.
  8. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, American Finance Association, vol. 57(1), pages 405-443, 02.
  9. Tao Wu & Glenn Rudebusch, 2003. "Macroeconomics and the Yield Curve," Computing in Economics and Finance 2003, Society for Computational Economics 206, Society for Computational Economics.
  10. Clive G. Bowsher, 2004. "Modelling the Dynamics of Cross-Sectional Price Functions: an Econometric Analysis of the Bid and Ask Curves of an Automated Exchange," OFRC Working Papers Series, Oxford Financial Research Centre 2004fe19, Oxford Financial Research Centre.
  11. Clive G. Bowsher & Roland Meeks, 2006. "The Impossibility of Stationary Yield Spreads and I(1) Yields under the Expectations Theory of the Term Structure," Economics Papers, Economics Group, Nuffield College, University of Oxford 2006-W05, Economics Group, Nuffield College, University of Oxford.
  12. De Pooter, Michiel & Ravazzolo, Francesco & van Dijk, Dick, 2006. "Predicting the term structure of interest rates incorporating parameter uncertainty, model uncertainty and macroeconomic information," MPRA Paper 2512, University Library of Munich, Germany, revised 03 Mar 2007.
  13. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(4), pages 745-787, May.
  14. Pagan, A.R. & Hall, A.D. & Martin, V., 1995. "Modelling the Term Structure," Papers, Australian National University - Department of Economics 284, Australian National University - Department of Economics.
  15. Borus Jungbacker & Siem Jan Koopman, 2008. "Likelihood-based Analysis for Dynamic Factor Models," Tinbergen Institute Discussion Papers, Tinbergen Institute 08-007/4, Tinbergen Institute, revised 20 Mar 2014.
  16. Zellner, A., 1992. "Statistics, Science and Public Policy," Papers, California Irvine - School of Social Sciences 92-21, California Irvine - School of Social Sciences.
  17. Shea, Gary S, 1992. "Benchmarking the Expectations Hypothesis of the Interest-Rate Term Structure: An Analysis of Cointegration Vectors," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 10(3), pages 347-66, July.
  18. Hall, Anthony D & Anderson, Heather M & Granger, Clive W J, 1992. "A Cointegration Analysis of Treasury Bill Yields," The Review of Economics and Statistics, MIT Press, vol. 74(1), pages 116-26, February.
  19. McCulloch, J Huston, 1975. "The Tax-Adjusted Yield Curve," Journal of Finance, American Finance Association, American Finance Association, vol. 30(3), pages 811-30, June.
  20. Brian Sack, 2000. "Using Treasury STRIPS to measure the yield curve," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2000-42, Board of Governors of the Federal Reserve System (U.S.).
  21. Mark Fisher & Douglas Nychka & David Zervos, 1995. "Fitting the term structure of interest rates with smoothing splines," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 95-1, Board of Governors of the Federal Reserve System (U.S.).
  22. Philippe C. Besse, 2000. "Autoregressive Forecasting of Some Functional Climatic Variations," Scandinavian Journal of Statistics, Danish Society for Theoretical Statistics;Finnish Statistical Society;Norwegian Statistical Association;Swedish Statistical Association, Danish Society for Theoretical Statistics;Finnish Statistical Society;Norwegian Statistical Association;Swedish Statistical Association, vol. 27(4), pages 673-687.
  23. Daniel F. Waggoner, 1997. "Spline methods for extracting interest rate curves from coupon bond prices," Working Paper, Federal Reserve Bank of Atlanta 97-10, Federal Reserve Bank of Atlanta.
  24. Jean Boivin & Serena Ng, 2005. "Understanding and Comparing Factor-Based Forecasts," NBER Working Papers 11285, National Bureau of Economic Research, Inc.
  25. Clements, M.P. & Hendry, D., 1992. "On the Limitations of Comparing Mean Square Forecast Errors," Economics Series Working Papers, University of Oxford, Department of Economics 99138, University of Oxford, Department of Economics.
  26. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 60(4), pages 473-89, October.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. 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.
  2. Borus Jungbacker & Siem Jan Koopman & Michel van der Wel, 0000. "Dynamic Factor Models with Smooth Loadings for Analyzing the Term Structure of Interest Rates," Tinbergen Institute Discussion Papers, Tinbergen Institute 09-041/4, Tinbergen Institute, revised 17 Sep 2010.
  3. repec:dgr:uvatin:0000041 is not listed on IDEAS
  4. Joao Frois Caldeira & Guilherme Valle Moura & Marcelo Savino Portugal, 2011. "Efficient Interest Ratecurve Estimation And Forecasting In Brazil," Anais do XXXVII Encontro Nacional de Economia [Proceedings of the 37th Brazilian Economics Meeting], ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of 133, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
  5. Borus Jungbacker & Siem Jan Koopman & Michel van der Wel, 2009. "Smooth Dynamic Factor Analysis with an Application to the U.S. Term Structure of Interest Rates," CREATES Research Papers 2009-39, School of Economics and Management, University of Aarhus.
  6. Koopman, Siem Jan & van der Wel, Michel, 2013. "Forecasting the US term structure of interest rates using a macroeconomic smooth dynamic factor model," International Journal of Forecasting, Elsevier, Elsevier, vol. 29(4), pages 676-694.
  7. Tabak, B.M. & Sollaci, A.B. & Gomes, G.M. & Cajueiro, D.O., 2012. "Forecasting the yield curve for the Euro region," Economics Letters, Elsevier, Elsevier, vol. 117(2), pages 513-516.
  8. Borus Jungbacker & Siem Jan Koopman & Michel van der Wel, 0000. "Dynamic Factor Models with Smooth Loadings for Analyzing the Term Structure of Interest Rates," Tinbergen Institute Discussion Papers, Tinbergen Institute 09-041/4, Tinbergen Institute, revised 17 Sep 2010.
  9. Gregory R. Duffee, 2012. "Forecasting interest rates," Economics Working Paper Archive, The Johns Hopkins University,Department of Economics 599, The Johns Hopkins University,Department of Economics.
  10. Jens H. E. Christensen & Francis X. Diebold & Glenn D. Rudebusch, 2008. "An Arbitrage-Free Generalized Nelson-Siegel Term Structure Model," PIER Working Paper Archive, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 08-030, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  11. Ito, Ryoko, 2013. "Modeling dynamic diurnal patterns in high frequency financial data," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 1315, Faculty of Economics, University of Cambridge.
  12. Dick van Dijk & Siem Jan Koopman & Michel van der Wel & Jonathan H. Wright, 2012. "Forecasting Interest Rates with Shifting Endpoints," Tinbergen Institute Discussion Papers, Tinbergen Institute 12-076/4, Tinbergen Institute.
  13. Wolfgang Karl Härdle,Piotr Majer & Melanie Schienle, 2012. "Yield Curve Modeling and Forecasting using Semiparametric Factor Dynamics," SFB 649 Discussion Papers SFB649DP2012-048, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  14. Siem Jan Koopman & Michel van der Wel, 2011. "Forecasting the U.S. Term Structure of Interest Rates using a Macroeconomic Smooth Dynamic Factor Model," Tinbergen Institute Discussion Papers, Tinbergen Institute 11-063/4, Tinbergen Institute.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:nuf:econwp:0805. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Maxine Collett).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.