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Beating the Random Walk: a Performance Assessment of Long-term Interest Rate Forecasts

Listed author(s):
  • Frank A.G. den Butter

    ()

    (VU University Amsterdam)

  • Pieter W. Jansen

    (Aegon Investment Management)

This paper has led to a publication in Applied Financial Economics , 2013, 23(9), 749-765. This paper assesses the performance of a number of long-term interest rate forecast approaches, namely time series models, structural economic models, expert forecasts and combinations thereof. The predictive performance of these approaches is compared using out of sample forecast errors, where a random walk forecast acts as benchmark. It is found that for five major OECD countries, namely United States, Germany, United Kingdom, The Netherlands and Japan, the other forecasting approaches do not outperform the random walk, or a somewhat more sophisticated time series model, on a 3 month forecast horizon. On a 12 month forecast horizon the random walk model can be outperformed by a model that combines economic data and expert forecasts. Here several methods of combination are considered: equal weights, optimized weights and weights based on forecast error. It appears that the additional information contents of the structural models and expert knowledge is only relevant for forecasting 12 months ahead.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 08-102/3.

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Date of creation: 28 Oct 2008
Handle: RePEc:tin:wpaper:20080102
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  1. Frank Butter & Simon Dijken, 1997. "The Information Contents of Aggregated Money Demand in the EMU," Open Economies Review, Springer, vol. 8(3), pages 233-244, July.
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  3. Boivin, Jean & Ng, Serena, 2006. "Are more data always better for factor analysis?," Journal of Econometrics, Elsevier, vol. 132(1), pages 169-194, May.
  4. Frank A. G. Den Butter & Pieter Jansen, 2004. "An empirical analysis of the German long-term interest rate," Applied Financial Economics, Taylor & Francis Journals, vol. 14(10), pages 731-741.
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  9. Yvon Fauvel & Alain Paquet & Christian Zimmermann, 1999. "A Survey on Interest Rate Forecasting," Cahiers de recherche CREFE / CREFE Working Papers 87, CREFE, Université du Québec à Montréal.
  10. Franses, Ph.H.B.F. & Kranendonk, H.C. & Lanser, D., 2007. "On the optimality of expert-adjusted forecasts," Econometric Institute Research Papers EI 2007-38, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  11. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
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  15. Yeung Lewis Chan & James H. Stock & Mark W. Watson, 1999. "A dynamic factor model framework for forecast combination," Spanish Economic Review, Springer;Spanish Economic Association, vol. 1(2), pages 91-121.
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