Non-linear interest rate dynamics and forecasting: evidence for US and Australian interest rates
David G. McMillan
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David G. McMillan: School of Management, University of St Andrews, UK, Postal: School of Management, University of St Andrews, UK
International Journal of Finance & Economics, 2009, vol. 14, issue 2, 139-155
Recent empirical finance research has suggested the potential for interest rate series to exhibit non-linear adjustment to equilibrium. This paper examines a variety of models designed to capture these effects and compares both their in-sample and out-of-sample performance with a linear alternative. Using short- and long-term interest rates we report evidence that a logistic smooth-transition error-correction model is able to best characterize the data and provide superior out-of-sample forecasts, especially for the short rate, over both linear and non-linear alternatives. This model suggests that market dynamics differ depending on whether the deviations from long-run equilibrium are above or below the threshold value. Copyright © 2007 John Wiley & Sons, Ltd.
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