Affine term structure model with macroeconomic factors: do no-arbitrage restriction and macroeconomic factors imply better out-of-sample forecasts?

Author Affiliation

Wali Ullah is Assistant Professor & Research Fellow-CBER at Institute of Business Administration (IBA), Karachi

Faculty / School

Faculty of Business Administration (FBA)

Department

Department of Economics

Was this content written or created while at IBA?

Yes

Document Type

Article

Source Publication

Journal of Forecasting

ISSN

0277-6693

Disciplines

Accounting | Business | Business Administration, Management, and Operations | Computer Sciences | Economics | Mathematics

Abstract

This study extends the affine dynamic Nelson–Siegel model for the inclusion of macroeconomic variables. Five macroeconomic variables are included in affine term structure model, derived under the arbitrage-free restriction, to evaluate their role in the in-sample fitting and out-of-sample forecasting of the term structure. We show that the relationship between the macroeconomic factors and yield data has an intuitive interpretation, and that there is interdependence between the yield and macroeconomic factors. Moreover, the macroeconomic factors significantly improve the forecast performance of the model. The affine Nelson–Siegel type models outperform the benchmark simple time series forecast models. The out-of-sample predictability of the affine Nelson–Siegel model with macroeconomic factors for the short horizon is superior to the simple affine yield model for all maturities, and for longer horizons the former is still compatible to the latter, particularly for medium and long maturities.

Indexing Information

HJRS - X Category, Scopus, Web of Science - Social Sciences Citation Index (SSCI)

Journal Quality Ranking

Impact Factor: 2.306

Publication Status

Published

Link to Full Text

Find in your library

Off-Campus Access

Share

COinS