Forecasting the yield curve: the role of additional and time‐varying decay parameters, conditional heteroscedasticity, and macro‐economic factors

In this article, we analyse the forecasting performance of several parametric extensions of the popular Dynamic Nelson–Siegel (DNS) model for the yield curve. Our focus is on the role of additional and time‐varying decay parameters, conditional heteroscedasticity, and macroeconomic variables. We also consider the role of several popular restrictions on the dynamics of the factors. Using a novel dataset of end‐of‐month continuously compounded Treasury yields on US zero‐coupon bonds and frequentist estimation based on the extended Kalman filter, we show that a second decay parameter does not contribute to better forecasts. In concordance with the preferred habitat theory, we also show that the best forecasting model depends on the maturity. For short maturities, the best performance is obtained in a heteroscedastic model with a time‐varying decay parameter. However, for long maturities, neither the time‐varying decay nor the heteroscedasticity plays any role, and the best forecasts are obtained in the basic DNS model with the shape of the yield curve depending on macroeconomic activity. Finally, we find that assuming non‐stationary factors is helpful in forecasting at long horizons.

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Publication Details

Journal
Journal of Time Series Analysis
Published
2024-09-09
DOI
https://doi.org/10.1111/jtsa.12769
Citations
2
Primary Topic
Stochastic processes and financial applications
Type
article
Field-Weighted Citation Impact
1.08

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article

Forecasting the yield curve: the role of additional and time‐varying decay parameters, conditional heteroscedasticity, and macro‐economic factors

André Alves Portela Santos, Esther Ruiz, Werley Cordeiro, João F. Caldeira
2 citations
Journal of Time Series Analysis
Stochastic processes and financial applications
1.08
article

Forecasting the yield curve: the role of additional and time‐varying decay parameters, conditional heteroscedasticity, and macro‐economic factors

André Alves Portela Santos, Esther Ruiz, Werley Cordeiro, João F. Caldeira
article en
2 citations

Abstract

In this article, we analyse the forecasting performance of several parametric extensions of the popular Dynamic Nelson–Siegel (DNS) model for the yield curve. Our focus is on the role of additional and time‐varying decay parameters, conditional heteroscedasticity, and macroeconomic variables. We also consider the role of several popular restrictions on the dynamics of the factors. Using a novel dataset of end‐of‐month continuously compounded Treasury yields on US zero‐coupon bonds and frequentist estimation based on the extended Kalman filter, we show that a second decay parameter does not contribute to better forecasts. In concordance with the preferred habitat theory, we also show that the best forecasting model depends on the maturity. For short maturities, the best performance is obtained in a heteroscedastic model with a time‐varying decay parameter. However, for long maturities, neither the time‐varying decay nor the heteroscedasticity plays any role, and the best forecasts are obtained in the basic DNS model with the shape of the yield curve depending on macroeconomic activity. Finally, we find that assuming non‐stationary factors is helpful in forecasting at long horizons.

Journal of Time Series AnalysisVol. 46(2)
Universidade Federal de Santa Catarina (BR), CUNEF Universidad, Universidad Carlos III de Madrid (ES)
Comunidad de Madrid, Conselho Nacional de Desenvolvimento Científico e Tecnológico, Universidad de Zaragoza, Agencia Estatal de Investigación
Openalex Percentile: Top 21%
Stochastic processes and financial applications
1.08
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