Forecasting the Term Structure of Government Bond Yields Using Credit Spreads and Structural Breaks

Azamat Abdymomunov (), Kyu Ho Kang () and Ki Jeong Kim ()
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Azamat Abdymomunov: The Federal Reserve Bank of Richmond
Kyu Ho Kang: Department of Economics, Korea University
Ki Jeong Kim: The Bank of Korea

No 2014-19, Working Papers from Economic Research Institute, Bank of Korea

Abstract: In this paper, we investigate whether credit spread curve information helps forecast the government bond yield curve and whether the joint dynamics of the government bond yields and credit spreads have structural changes. For this purpose, we use a joint dynamic Nelson-Siegel (DNS) model of the term structures of U.S. Treasury interest rates and credit spreads. We find that this joint model produces substantially more accurate out-of-sample Treasury yields forecasts compared with a standard DNS yield curve only model. We also find that the predictive gain from incorporating the credit spread curve information substantially increases if the joint model accounts for structural changes in the dynamics of yield and credit spread curves. In addition, our model incorporates a zero lower bound restriction ensuring that our predictions are economically plausible.

Keywords: Out-of-sample forecasting; term structure; credit spread; Nelson-Siegel model; Bayesian MCMC estimation (search for similar items in EconPapers)
JEL-codes: C11 C53 E43 E47 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2014-07-18
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http://papers.bok.or.kr/RePEc_attach/wpaper/english/wp-2014-19.pdf Working Paper, 2014 (application/pdf)

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