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Forecasting Government Bond Yields with Large Bayesian VARs

Andrea Carriero (), George Kapetanios () and Massimiliano Marcellino
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George Kapetanios: Queen Mary, University of London

No 662, Working Papers from Queen Mary University of London, School of Economics and Finance

Abstract: We propose a new approach to forecasting the term structure of interest rates, which allows to efficiently extract the information contained in a large panel of yields. In particular, we use a large Bayesian Vector Autoregression (BVAR) with an optimal amount of shrinkage towards univariate AR models. Focusing on the U.S., we provide an extensive study on the forecasting performance of our proposed model relative to most of the existing alternative specifications. While most of the existing evidence focuses on statistical measures of forecast accuracy, we also evaluate the performance of the alternative forecasts when used within trading schemes or as a basis for portfolio allocation. We extensively check the robustness of our results via subsample analysis and via a data based Monte Carlo simulation. We find that: i) our proposed BVAR approach produces forecasts systematically more accurate than the random walk forecasts, though the gains are small; ii) some models beat the BVAR for a few selected maturities and forecast horizons, but they perform much worse than the BVAR in the remaining cases; iii) predictive gains with respect to the random walk have decreased over time; iv) different loss functions (i.e., "statistical" vs "economic") lead to different ranking of specific models; v) modelling time variation in term premia is important and useful for forecasting.

Keywords: Bayesian methods; Forecasting; Term structure (search for similar items in EconPapers)
JEL-codes: C11 C53 E43 E47 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-fmk and nep-for
Date: 2010-04
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Working Paper: Forecasting Government Bond Yields with Large Bayesian VARs (2010) Downloads
Working Paper: Forecasting Government Bond Yields with Large Bayesian VARs (2010) Downloads
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