The Forecasting Ability of Factor Models of the Term Structure of IRS Markets

Pilar Abad and Alfonso Novales

Documentos de Trabajo del ICAE from Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico

Abstract: Using estimated principal components as factors, three-factors models are shown to produce forecasts comparable to those of autoregressive models for 2 to 10 year zaero coupon interest rates IRS markets both, for short- and medium- term forecasting horizons. Evidence is provided for the Deutsche mark, Spanish peseta, Japanese yen and US Dollar. Forecast from factor models are also shown to preserve the correlation matrix of interest rates across a given term structure, an important proprerty regarding risk management. The result is quite striking, because factor models are purely static, and forecasts for the factors must be obtained in advance of interest rate forecast.factor models

Keywords: Factor models; Term structure of interest rates; Principal components; Swap markets; IRS (search for similar items in EconPapers)
JEL-codes: E37 E43 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2002
New Economics Papers: this item is included in nep-fin
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