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Can forward rates be used to improve interest rate forecasts?

Listed author(s):
  • Emilio Dominguez
  • Alfonso Novales

This paper evaluates the extent to which the explanatory power detected in the term structure in different markets and countries can actually be used to produce sensible forecasts of future short-term interest rates. Specifically, in spite of the forecasting connotation of the unbiasedness property of forward rates, actual evaluation of their forecasting performance has received scant attention in the literature on the term structure. This study uses monthly data for 1978-1998 on interest rates on Eurodeposits on the US dollar, yen, Deutsche mark, British pound, Spanish peseta, French franc, Italian lira and Swiss franc, comparing forecasts obtained from forward rates to those obtained from univariate autoregressions. By themselves, forward rates produce better one-step ahead forecasts, as well as better once-and-for all forecasts of 1-month interest rates over a full year horizon than those obtained from the own past of interest rates. The gain in one-step ahead forecasting disappears for longer maturities, although forward rates still produce better once-and-for all predictions of 3- and 6-month interest rates than univariate autoregressions for a number of currencies.

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File URL: http://www.tandfonline.com/doi/abs/10.1080/09603100010007346
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Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 12 (2002)
Issue (Month): 7 ()
Pages: 493-504

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Handle: RePEc:taf:apfiec:v:12:y:2002:i:7:p:493-504
DOI: 10.1080/09603100010007346
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  1. Mishkin, Frederic S, 1988. "The Information in the Term Structure: Some Further Results," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 3(4), pages 307-314, October-D.
  2. N. Gregory Mankiw & Lawrence H. Summers, 1984. "Do Long-Term Interest Rates Overreact to Short-Term Interest Rates?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(1), pages 223-248.
  3. Jorion, Philippe & Mishkin, Frederic, 1991. "A multicountry comparison of term-structure forecasts at long horizons," Journal of Financial Economics, Elsevier, vol. 29(1), pages 59-80, March.
  4. Fama, Eugene F., 1976. "Forward rates as predictors of future spot rates," Journal of Financial Economics, Elsevier, vol. 3(4), pages 361-377, October.
  5. N. Gregory Mankiw & Jeffrey A. Miron, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 101(2), pages 211-228.
  6. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
  7. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(1), pages 173-224.
  8. Campbell, John Y & Shiller, Robert J, 1987. "Cointegration and Tests of Present Value Models," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 1062-1088, October.
  9. Fama, Eugene F., 1990. "Term-structure forecasts of interest rates, inflation and real returns," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 59-76, January.
  10. Richard Deaves, 1996. "Forecasting Canadian Short-Term Interest Rates," Canadian Journal of Economics, Canadian Economics Association, vol. 29(3), pages 615-634, August.
  11. Wahab, Mahmoud, 1997. "On risk, rationality and the predictive ability of European short-term adjusted yield spreads," Journal of International Money and Finance, Elsevier, vol. 16(5), pages 737-765, September.
  12. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-692, September.
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