No‐arbitrage priors, drifting volatilities, and the term structure of interest rates

Andrea Carriero, Todd Clark and Massimiliano Marcellino

Journal of Applied Econometrics, 2021, vol. 36, issue 5, 495-516

Abstract: We use a Bayesian vector autoregression with stochastic volatility to forecast government bond yields. We form the conjugate prior from a no‐arbitrage affine term structure model. The model improves on the accuracy of point and density forecasts from a no‐change random walk and an affine term structure model with stochastic volatility. Our proposed approach may succeed by relaxing the no‐arbitrage affine term structure model's requirements that yields obey a factor structure and that the factors follow a Markov process. In the term structure model, its cross‐equation no‐arbitrage restrictions on the factor loadings appear to play a marginal role in forecasting gains.

Date: 2021
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https://doi.org/10.1002/jae.2828

Related works:
Working Paper: No-Arbitrage Priors, Drifting Volatilities, and the Term Structure of Interest Rates (2020)
Working Paper: No Arbitrage Priors, Drifting Volatilities, and the Term Structure of Interest Rates (2014)
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