Forecasting the Brazilian Yield Curve Using Forward-Looking Variables

Fausto Vieira, Fernando Chague and Marcelo Fernandes
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Fausto Vieira: Fundação Getulio Vargas (FGV)

No 799, Working Papers from Queen Mary University of London, School of Economics and Finance

Abstract: This paper proposes a forecasting model that combines a factor augmented VAR (FAVAR) methodology with the Nelson and Siegel (NS) parametrization of the yield curve to predict the Brazilian term structure of interest rates. Importantly, we extract the principal components for the FAVAR from a large data set containing forward-looking macroeconomic and financial variables. Our forecasting model significantly improves the predicting accuracy of extant models in the literature, particularly at short-term horizons. For instance, the mean absolute forecast errors are 15-40% lower than the random walk benchmark on predictions at the three month horizon. The out-of-sample analysis shows that including forward-looking indicators is the key to improve the predictive ability of the model.

Keywords: Bonds; Factor-augmented VAR; Forecasting; term structure; Yield curve (search for similar items in EconPapers)
JEL-codes: C38 E47 E58 (search for similar items in EconPapers)
Date: 2016-08-24
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Journal Article: Forecasting the Brazilian yield curve using forward-looking variables (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:qmw:qmwecw:799

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