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Term structure forecasting using macro factors and forecast combination

  • Michiel de Pooter

    ()

    (Federal Reserve Board)

  • Francesco Ravazzolo

    ()

    (Norges Bank (Central Bank of Norway))

  • Dick van Dijk

    ()

    (Erasmus University, Rotterdam)

We examine the importance of incorporating macroeconomic information and, in particular, accounting for model uncertainty when forecasting the term structure of U.S.interest rates. We start off by analyzing and comparing the forecast performance of several individual term structure models. Our results confirm and extend results found in previous literature that adding macroeconomic information, through factors extracted from a large number of individual series, tends to improve interest rate forecasts. We then show, however, that the predictive power of individual models varies over time significantly. Models with macro factors are the more accurate in and around recession periods. Models without macro factors do particularly well in low-volatility subperiods such as the late 1990s. We demonstrate that this problem of model uncertainty can be mitigated by combining individual model forecasts. Combining forecasts leads to encouraging gains in predictability, especially for longer-dated maturities, and importantly, these gains are consistent over time.

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File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2010/WP-201001/
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Paper provided by Norges Bank in its series Working Paper with number 2010/01.

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Length: 47 pages
Date of creation: 01 Mar 2010
Date of revision:
Handle: RePEc:bno:worpap:2010_01
Note: First version:
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