A rotated Dynamic Factor Model for the yield curve: squeezing out information when it matters

Chiara Casoli () and Riccardo (Jack) Lucchetti
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Chiara Casoli: InsIDE Lab, DiEco, Universita' degli Studi dell'Insubria, Fondazione Eni Enrico Mattei

No 503, Working Papers from Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali

Abstract: The yield curve is widely regarded as a powerful descriptor of the economy and market expectations. A common approach to its statistical representation relies on a small number of factors summarizing the curve, which can then be used to forecast real economic activity. We argue that optimal factor extraction is crucial for retrieving information when considering an approximate factor model. By introducing a rotation of the model including cointegration, we reduce cross-sectional dependence in the idiosyncratic components. This leads to improved forecasts of key macroeconomic variables during periods of economic and financial instability, both in the US and the euro area.

Keywords: Yield curve; Nelson-Siegel model; Dynamic Factor Model; cointegration; forecasting (search for similar items in EconPapers)
JEL-codes: C32 C53 E43 (search for similar items in EconPapers)
Pages: 31
Date: 2026-01
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