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A dynamic Nelson–Siegel model with forward-looking macroeconomic factors for the yield curve in the US

Marcelo Fernandes () and Fausto Vieira

Journal of Economic Dynamics and Control, 2019, vol. 106, issue C, -

Abstract: This paper employs a factor-augmented dynamic Nelson–Siegel (FADNS) model to predict the yield curve in the US that relies on a large data set of mostly forward-looking macroeconomic variables. FADNS models significantly improve interest rate forecasts relative to many extant models in the literature. For longer horizons, it outperforms autoregressive alternatives, with reductions in mean absolute forecast error of up to 18% using quarterly data and of up to 40% at higher frequencies. For shorter horizons, it is still competitive against autoregressive forecasts, outclassing them for 7- and 10-year yields. The out-of-sample analysis reveals that the forward-looking nature of the indicators we employ is crucial for improving forecasting performance. Including them indeed reduces the mean absolute error with respect to specifications based on backward-looking macroeconomic indicators for any model we consider.

Keywords: Factor-augmented VAR; Forecasting; Term structure of interest rates (search for similar items in EconPapers)
JEL-codes: E58 C38 E47 (search for similar items in EconPapers)
Date: 2019
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