Improving market-based forecasts of short-term interest rates: Time-varying stationarity and the predictive content of switching regime-expectations

Ralf Ahrens

No 1999/14, CFS Working Paper Series from Center for Financial Studies (CFS)

Abstract: Modeling short-term interest rates as following regime-switching processes has become increasingly popular. Theoretically, regime-switching models are able to capture rational expectations of infrequently occurring discrete events. Technically, they allow for potential time-varying stationarity. After discussing both aspects with reference to the recent literature, this paper provides estimations of various univariate regime-switching specifications for the German three-month money market rate and bivariate specifications additionally including the term spread. However, the main contribution is a multi-step out-of-sample forecasting competition. It turns out that forecasts are improved substantially when allowing for state-dependence. Particularly, the informational content of the term spread for future short rate changes can be exploited optimally within a multivariate regime-switching framework.

Keywords: interest rates; term structure; peso problem; regime-switching; forecasting (search for similar items in EconPapers)
JEL-codes: C32 C53 E43 E44 G12 (search for similar items in EconPapers)
Date: 1999
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:cfswop:199914

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