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Term Structure Forecasting: No‐Arbitrage Restrictions versus Large Information Set

  • Carlo A. Favero
  • Linlin Niu
  • Luca Sala

This paper addresses the issue of forecasting the term structure. We provide a unified state-space modelling framework that encompasses different existing discrete-time yield curve models. Within such framework we analyze the impact of two modelling choices, namely the imposition of no-arbitrage restrictions and the size of the information set used to extract factors, on the forecasting performance. Using US yield curve data, we find that both no-arbitrage and large info help in forecasting but no model uniformly dominates the other. No-arbitrage models are more useful at shorter horizon for shorter maturities. Large information sets are more useful at longer horizons and longer maturities. We also find evidence for a significant feedback from yield curve models to macroeconomic variables that could be exploited for macroeconomic forecasting.

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Article provided by John Wiley & Sons, Ltd. in its journal Journal of Forecasting.

Volume (Year): 31 (2012)
Issue (Month): 2 (03)
Pages: 124-156

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Handle: RePEc:wly:jforec:v:31:y:2012:i:2:p:124-156
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