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Term Structure Modeling and Forecasting of Government Bond Yields : Does Macroeconomic Factors Imply Better Out-of-Sample Forecasts?

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  • Wali Ullah
  • Yasumasa Matsuda
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    Abstract

    Accurate modeling and precise estimation of the term structure of interest rate are of crucial importance in many areas of finance and macroeconomics as it is the most important factor in the capital market and probably the economy. This study compares the in-sample fit and out-of-sample forecast accuracy of the CIR and Nelson-Siegel models. For the in-sample fit, there is a significant lack of information on the short-term CIR model. The CIR model should also be considered too poor to describe the term structure in a simulation based context. It generates a downward slope average yield curve. Contrary to CIR model, Nelson-Siegel model is not only compatible to fit attractively the yield curve but also accurately forecast the future yield for various maturities. Furthermore, the non-linear version of the Nelson-Siegel model outperforms the linearized one. In a simulation based context the Nelson-Siegel model is capable to replicate most of the stylized facts of the Japanese market yield curve. Therefore, it turns out that the Nelson-Siegel model (non-linear version) could be a good candidate among various alternatives to study the evolution of the yield curve in Japanese market.

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    File URL: http://hdl.handle.net/10097/56545
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    File URL: http://ir.library.tohoku.ac.jp/re/bitstream/10097/56545/1/terg304.pdf
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    Bibliographic Info

    Paper provided by Graduate School of Economics and Management, Tohoku University in its series TERG Discussion Papers with number 304.

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    Length: 36 pages
    Date of creation: Oct 2012
    Date of revision:
    Handle: RePEc:toh:tergaa:304

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    1. Diebold, Francis X. & Li, Canlin, 2003. "Forecasting the term structure of government bond yields," CFS Working Paper Series 2004/09, Center for Financial Studies (CFS).
    2. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-92, September.
    3. Wali Ullah & Yoshihiko Tsukuda & Yasumasa Matsuda, 2012. "Term Structure Forecasting of Government Bond Yields with Latent and Macroeconomic Factors: Does Macroeconomic Factors Imply Better Out-of-Sample Forecasts?," TERG Discussion Papers 287, Graduate School of Economics and Management, Tohoku University.
    4. de Jong, Frank, 2000. "Time Series and Cross-Section Information in Affine Term-Structure Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 18(3), pages 300-314, July.
    5. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October.
    6. Michiel De Pooter, 2007. "Examining the Nelson-Siegel Class of Term Structure Models," Tinbergen Institute Discussion Papers 07-043/4, Tinbergen Institute.
    7. Vasicek, Oldrich A & Fong, H Gifford, 1982. " Term Structure Modeling Using Exponential Splines," Journal of Finance, American Finance Association, vol. 37(2), pages 339-48, May.
    8. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
    9. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 627-627, November.
    10. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-92.
    11. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
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