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Forecasting the yield curve: A statistical model with market survey data

  • Leite, André Luís
  • Filho, Romeu Braz Pereira Gomes
  • Vicente, José Valentim Machado
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    In this paper we propose a statistical model to forecast the yield curve, using two major sources of information: data from a market survey and the forward rate risk premium. We apply the model to forecast the Brazilian yield curve six months ahead and compare the results with the well-known model of Diebold and Li (2006), a random walk process and the predictions based on the forward rate. The proposed model produces accurate forecasts and outperforms all the competitor models in terms of root mean square error (RMSE).

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    Article provided by Elsevier in its journal International Review of Financial Analysis.

    Volume (Year): 19 (2010)
    Issue (Month): 2 (March)
    Pages: 108-112

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    Handle: RePEc:eee:finana:v:19:y:2010:i:2:p:108-112
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    1. Fabia A. de Carvalho & André Minella, 2009. "Market Forecasts in Brazil: performance and determinants," Working Papers Series 185, Central Bank of Brazil, Research Department.
    2. Campbell, John Y & Shiller, Robert J, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 495-514, May.
    3. Almeida, Caio & Vicente, José, 2008. "The role of no-arbitrage on forecasting: Lessons from a parametric term structure model," Journal of Banking & Finance, Elsevier, vol. 32(12), pages 2695-2705, December.
    4. Andrew Ang & Monika Piazzesi, 2001. "A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables," NBER Working Papers 8363, National Bureau of Economic Research, Inc.
    5. Jens H. E. Christensen & Francis X. Diebold & Glenn D. Rudebusch, 2007. "The Affine Arbitrage-Free Class of Nelson-Siegel Term Structure Models," PIER Working Paper Archive 07-029, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    6. Hordahl, Peter & Tristani, Oreste & Vestin, David, 2006. "A joint econometric model of macroeconomic and term-structure dynamics," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 405-444.
    7. Francis X. Diebold & Glenn D. Rudebusch & S. Boragan Aruoba, 2004. "The Macroeconomy and the Yield Curve: A Dynamic Latent Factor Approach," NBER Working Papers 10616, National Bureau of Economic Research, Inc.
    8. Eduardo J. A. Lima & Felipe Luduvice & Benjamin M. Tabak, 2006. "Forecasting Interest Rates: an application for Brazil," Working Papers Series 120, Central Bank of Brazil, Research Department.
    9. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
    10. Lars E.O. Svensson, 1994. "Monetary Policy with Flexible Exchange Rates and Forward Interest Rates as Indicators," NBER Working Papers 4633, National Bureau of Economic Research, Inc.
    11. Andrew Ang & Geert Bekaert & Min Wei, 2006. "Do macro variables, asset markets, or surveys forecast inflation better?," Finance and Economics Discussion Series 2006-15, Board of Governors of the Federal Reserve System (U.S.).
    12. Caio Almeida & Romeu Gomes & André Leite & Axel Simonsen & José Vicente, 2009. "Does Curvature Enhance Forecasting?," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 12(08), pages 1171-1196.
    13. Diebold, Francis X. & Piazzesi, Monica & Rudebusch, Glenn D., 2005. "Modeling bond yields in finance and macroeconomics," CFS Working Paper Series 2005/03, Center for Financial Studies (CFS).
    14. Francis X. Diebold & Canlin Li, 2002. "Forecasting the Term Structure of Government Bond Yields," Center for Financial Institutions Working Papers 02-34, Wharton School Center for Financial Institutions, University of Pennsylvania.
    15. Shiller, Robert J. & Huston McCulloch, J., 1990. "The term structure of interest rates," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 13, pages 627-722 Elsevier.
    16. Vicente, José & Tabak, Benjamin M., 2008. "Forecasting bond yields in the Brazilian fixed income market," International Journal of Forecasting, Elsevier, vol. 24(3), pages 490-497.
    17. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
    18. John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, vol. 95(1), pages 138-160, March.
    19. Dai, Qiang & Singleton, Kenneth J., 2002. "Expectation puzzles, time-varying risk premia, and affine models of the term structure," Journal of Financial Economics, Elsevier, vol. 63(3), pages 415-441, March.
    20. Yash P. Mehra, 2002. "Survey measures of expected inflation : revisiting the issues of predictive content and rationality," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 17-36.
    21. Huse, Cristian, 2011. "Term structure modelling with observable state variables," Journal of Banking & Finance, Elsevier, vol. 35(12), pages 3240-3252.
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