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Term Structure Forecasting of Government Bond Yields with Latent and Macroeconomic Factors: Does Macroeconomic Factors Imply Better Out-of-Sample Forecasts?

  • Wali Ullah
  • Yoshihiko Tsukuda
  • Yasumasa Matsuda

This study examines the role of macroeconomic and stock market variables in the dynamic Nelson-Siegel framework with the purpose of fitting and forecasting the term structure of interest rate. We find that incorporating the macroeconomic indicators in yield curve model leads to a better in-sample fit of the term structure. The out-of-sample predictability also improves significantly for all maturities for the short horizon forecasts, however regarding the longer horizons forecasts, the forecast performance of yields-macro and yields-only models is same for maturities beyond 5 years. The one-step state-space estimation approach employed to the yields-macro model produces accurate forecasts and outperforms the results of earlier related studies. Especially, the autocorrelation of the forecasts errors and in-sample residuals persistency across maturities, which is a common phenomenon in the statistical class of term structure models, can be reduced to a greater extent by inclusion of macroeconomic factors in the yield model.

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File URL: http://hdl.handle.net/10097/55764
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File URL: http://ir.library.tohoku.ac.jp/re/bitstream/10097/55764/1/terg287.pdf
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Paper provided by Graduate School of Economics and Management, Tohoku University in its series TERG Discussion Papers with number 287.

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Length: 49 pages
Date of creation: Oct 2012
Date of revision:
Handle: RePEc:toh:tergaa:287
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