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Can forward rates be used to improve interest rate forecasts?

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  • Emilio Dominguez
  • Alfonso Novales

Abstract

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.

Suggested Citation

  • Emilio Dominguez & Alfonso Novales, 2002. "Can forward rates be used to improve interest rate forecasts?," Applied Financial Economics, Taylor & Francis Journals, vol. 12(7), pages 493-504.
  • Handle: RePEc:taf:apfiec:v:12:y:2002:i:7:p:493-504
    DOI: 10.1080/09603100010007346
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    References listed on IDEAS

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    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.
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    Cited by:

    1. Hernandis, Lucía & Torró, Hipòlit, 2013. "The information content of Eonia swap rates before and during the financial crisis," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5316-5328.
    2. Minoas Koukouritakis & Leo Michelis, 2008. "The term structure of interest rates in the 12 newest EU countries," Applied Economics, Taylor & Francis Journals, vol. 40(4), pages 479-490.
    3. N. K. Kishor & H. A. Marfatia, 2013. "Does federal funds futures rate contain information about the treasury bill rate?," Applied Financial Economics, Taylor & Francis Journals, vol. 23(16), pages 1311-1324, August.
    4. Radim Gottwald, 2015. "The Forecasting of Spot Exchange Rates Based on the Forward Exchange Rates," MENDELU Working Papers in Business and Economics 2015-52, Mendel University in Brno, Faculty of Business and Economics.

    More about this item

    JEL classification:

    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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