Forecasting the Yield Curve in a Data‐Rich Environment Using the Factor‐Augmented Nelson–Siegel Model

Abstract

Various ways of extracting macroeconomic information from a data-rich environment are compared with the objective of forecasting yield curves using the Nelson-Siegel model. Five issues in factor extraction are addressed, namely, selection of a subset of the available information, incorporation of the forecast objective in constructing factors, specification of a multivariate forecast objective, data grouping before constructing factors, and selection of the number of factors in a data-driven way. Our empirical results show that each of these features helps to improve forecast accuracy, especially for the shortest and longest maturities. The data-driven methods perform well in relatively volatile periods, when simpler models do not suffice.

Modeling frailty-correlated defaults using many macroeconomic covariates

“…The methodology of relating observed variables to a small set of factors has been employed in the forecasting of inflation and production data, see Massimiliano et al (2003), asset returns and volatilities, see e.g. Ludvigson and Ng (2007), and the term structure of interest rates, see Exterkate et al (2010). These studies have reported favorable results when such macro factors are used for forecasting.…”

Forecasting interest rates with shifting endpoints

“…() and Exterkate et al . () document that macro factors contain valuable predictive information. Third, several recent papers use survey data in analysis of the term structure.…”

Forecasting the US Term Structure of Interest Rates Using Nonparametric Functional Data Analysis

“…This provides us with a panel of 480 monthly observations on 17 different maturities. Similar but shorter datasets have been considered by Moench (), Exterkate et al () and Laurini and Hotta ().…”

“…This approach is the so‐called equilibrium or affine‐class models, where time series techniques are used to model the dynamics of yield on a short‐term or instantaneous maturity, and yields for longer maturities are then derived using an affine model. In the context of yield curve forecasting with Nelson–Siegel type models, de Pooter et al (), Moench (), Exterkate et al () and Koopman and van der Wel () document that macro factors contain valuable predictive information.…”