Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/175236 
Year of Publication: 
2016
Series/Report no.: 
Working Paper No. 799
Publisher: 
Queen Mary University of London, School of Economics and Finance, London
Abstract: 
This paper proposes a forecasting model that combines a factor augmented VAR (FAVAR) methodology with the Nelson and Siegel (NS) parametrization of the yield curve to predict the Brazilian term structure of interest rates. Importantly, we extract the principal components for the FAVAR from a large data set containing forward-looking macroeconomic and financial variables. Our forecasting model significantly improves the predicting accuracy of extant models in the literature, particularly at short-term horizons. For instance, the mean absolute forecast errors are 15-40% lower than the random walk benchmark on predictions at the three month horizon. The out-of-sample analysis shows that including forward-looking indicators is the key to improve the predictive ability of the model.
Subjects: 
Bonds
Factor-augmented VAR
Forecasting
term structure
Yield curve
JEL: 
E58
C38
E47
Document Type: 
Working Paper

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