The Forecasting Ability of Factor Models of the Term Structure of IRS Markets
Using estimated principal components as factors, three-factors models are shown to produce forecasts comparable to those of autoregressive models for 2 to 10 year zaero coupon interest rates IRS markets both, for short- and medium- term forecasting horizons. Evidence is provided for the Deutsche mark, Spanish peseta, Japanese yen and US Dollar. Forecast from factor models are also shown to preserve the correlation matrix of interest rates across a given term structure, an important proprerty regarding risk management. The result is quite striking, because factor models are purely static, and forecasts for the factors must be obtained in advance of interest rate forecast.factor models
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- Engle, Robert F & Kozicki, Sharon, 1993.
"Testing for Common Features,"
Journal of Business & Economic Statistics,
American Statistical Association, vol. 11(4), pages 369-80, October.
- Knez, Peter J & Litterman, Robert & Scheinkman, Jose Alexandre, 1994. " Explorations into Factors Explaining Money Market Returns," Journal of Finance, American Finance Association, vol. 49(5), pages 1861-82, December.
- Niffikeer, Cindy I. & Hewins, Robin D. & Flavell, Richard B., 2000. "A synthetic factor approach to the estimation of value-at-risk of a portfolio of interest rate swaps," Journal of Banking & Finance, Elsevier, vol. 24(12), pages 1903-1932, December.
- Engle, Robert F & Kozicki, Sharon, 1993. "Testing for Common Features: Reply," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(4), pages 393-95, October.
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