Working Paper

Term structure forecasting using macro factors and forecast combination


Abstract: 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.

Keywords: Interest rates; Macroeconomics;

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File(s): File format is application/pdf http://www.federalreserve.gov/pubs/ifdp/2010/993/ifdp993.pdf

Authors

    Ravazzolo, Francesco

    Michiel De Pooter

    Dick Van Dijk

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 2010

Number: 993