Forecasting Short-Term Interest Rates With Out-Of-Model Expectations

The topic of yield curve modelling and forecasting covers various financial, macroeconomic and mathematical questions from the model choices and assumptions to the proper selection of external variables describing the economy and interest rate environment. In addition to that, a certain flexibility regarding the inclusion of out-of-model expectations can further improve the robustness of the model, provide reasonable forecasts more in line with the actual outlook or based on different scenarios, especially in volatile and uncertain regimes. In this paper, we present two different approaches for incorporating out-of-model expectations. Implementation and results on Hungarian data are also shown.