Functional Signal plus Noise (FSN) models are proposed for analysing the dynamics of a large cross-section of yields or asset prices in which contemporaneous observations are functionally related. The FSN models are used to forecast high dimensional yield curves for US Treasury bonds at the one month ahead horizon. The models achieve large reductions in mean square forecast errors relative to a random walk for yields and readily dominate both the Diebold and Li (2006) and random walk forecasts across all maturities studied. We show that the Expectations Theory (ET) of the term structure completely determines the conditional mean of any zero-coupon yield curve. This enables a novel evaluation of the ET in which its 1-step ahead forecasts are compared with those of rival methods such as the FSN models, with the results strongly supporting the growing body of empirical evidence against the ET. Yield spreads do provide important information for forecasting the yield curve, especially in the case of shorter maturities, but not in the manner prescribed by the Expectations Theory.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
file. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Publisher Info
Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number
2006fe11.
Find related papers by JEL classification: C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
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.:
Cited by: (explanations, 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.)