This article has greatly benefited from several comments and detailed suggestions by three anonymous referees and by Frank Schorfheide. I also thank seminar participants at the University of Bristol, at the EC2 meeting in Faro, and at the London-OxBridge Time Series Workshop in LSE. Errors are mine. Please address correspondence to: Andrea Carriero, Department of Economics, Queen Mary, University of London, Mile End Road, London E1 4NS, U.K. Phone: +44-20-7882-8050. E-mail: email@example.com.
FORECASTING THE YIELD CURVE USING PRIORS FROM NO-ARBITRAGE AFFINE TERM STRUCTURE MODELS*
Article first published online: 25 APR 2011
© (2011) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association
International Economic Review
Volume 52, Issue 2, pages 425–459, May 2011
How to Cite
Carriero, A. (2011), FORECASTING THE YIELD CURVE USING PRIORS FROM NO-ARBITRAGE AFFINE TERM STRUCTURE MODELS. International Economic Review, 52: 425–459. doi: 10.1111/j.1468-2354.2011.00634.x
Manuscript received September 2007; revised October 2008.
- Issue published online: 25 APR 2011
- Article first published online: 25 APR 2011
I propose a strategy for forecasting the term structure of interest rates that may produce significant gains in predictive accuracy. The key idea is to use the restrictions implied by Gaussian, no-arbitrage, affine term structure models on a vector autoregression as prior information instead of imposing the restrictions dogmatically. This allows us to account for possible model misspecification. We use the proposed method to forecast a system of five U.S. yields up to 12 months ahead, and we find it provides significant gains in forecast accuracy.