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Decision-Based Forecast Evaluation of UK Interest Rate Predictability

  • Stephen Hall

    ()

  • Kavita Sirichand

    ()

This paper illustrates the importance of density forecasting in portfolio decision making involving bonds of different maturities. The forecast performance of an atheoretic and a theory informed model of bond returns is evaluated. The decision making environment is fully described for an investor seeking to optimally allocate his portfolio between long and short Treasury Bills, over investment horizons of up to two years. Using weekly data over 1997 to 2007 we examine the impact of parameter uncertainty and predictability in returns on the investor's allocation. We describe how the forecasts are computed and used in this context. Both statistical and decision-based criteria are used to assess the out-of-sample forecasting performance of the models. Our results show sensitivity to the evaluation criterion used. In the context of investment decision making under an economic value criterion, we find some potential gain for the investor from assuming predictability.

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File URL: http://www.le.ac.uk/economics/research/repec/lec/leecon/dp10-09.pdf
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Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 10/09.

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Date of creation: Mar 2010
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Handle: RePEc:lec:leecon:10/09
Contact details of provider: Postal: Department of Economics University of Leicester, University Road. Leicester. LE1 7RH. UK
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Web page: http://www2.le.ac.uk/departments/economics
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  1. Pasquale Della Corte & Lucio Sarno & Daniel L. Thornton, 2007. "The expectation hypothesis of the term structure of very short-term rates: statistical tests and economic value," Working Papers 2006-061, Federal Reserve Bank of St. Louis.
  2. Sarno, Lucio & Thornton, Daniel L. & Valente, Giorgio, 2007. "The Empirical Failure of the Expectations Hypothesis of the Term Structure of Bond Yields," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(01), pages 81-100, March.
  3. De Pooter, Michiel & Ravazzolo, Francesco & van Dijk, Dick, 2006. "Predicting the term structure of interest rates incorporating parameter uncertainty, model uncertainty and macroeconomic information," MPRA Paper 2512, University Library of Munich, Germany, revised 03 Mar 2007.
  4. repec:dgr:uvatin:20070028 is not listed on IDEAS
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