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Accurate Short-Term Yield Curve Forecasting using Functional Gradient Descent

  • Fabio Trojani

We propose a multivariate nonparametric technique for generating reliable short-term historical yield curve scenarios and confidence intervals. The approach is based on a Functional Gradient Descent (FGD) estimation of the conditional mean vector and covariance matrix of a multivariate interest rate series. It is computationally feasible in large dimensions and it can account for nonlinearities in the dependence of interest rates at all available maturities. Based on FGD we apply filtered historical simulation to compute reliable out-of-sample yield curve scenarios and confidence intervals. We back-test our methodology on daily USD bond data for forecasting horizons from 1 to 10 days. Based on several statistical performance measures we find significant evidence of a higher predictive power of our method when compared to scenarios generating techniques based on (i) factor analysis, (ii) a multivariate CCC-GARCH model, or (iii) an exponential smoothing covariances estimator as in the RiskMetrics-super-TM approach. Copyright , Oxford University Press.

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Article provided by Society for Financial Econometrics in its journal Journal of Financial Econometrics.

Volume (Year): 5 (2007)
Issue (Month): 4 (Fall)
Pages: 591-623

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Handle: RePEc:oup:jfinec:v:5:y:2007:i:4:p:591-623
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  1. Gourieroux,Christian, 2000. "Econometrics of Qualitative Dependent Variables," Cambridge Books, Cambridge University Press, number 9780521589857.
  2. Loriano Mancini & Elvezio Ronchetti & Fabio Trojani, 2004. "Optimal Conditionally Unbiased Bounded-Influence Inference in Dynamic Location and Scale Models," Research Papers by the Institute of Economics and Econometrics, Geneva School of Economics and Management, University of Geneva 2004.04, Institut d'Economie et Econométrie, Université de Genève.
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