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Statistical Methods & Applications

, Volume 26, Issue 3, pp 453–483 | Cite as

Term structure forecasting in affine framework with time-varying volatility

  • Wali Ullah
Original Paper
  • 136 Downloads

Abstract

This study extends the affine Nelson–Siegel model by introducing the time-varying volatility component in the observation equation of yield curve, modeled as a standard EGARCH process. The model is illustrated in state-space framework and empirically compared to the standard affine and dynamic Nelson–Siegel model in terms of in-sample fit and out-of-sample forecast accuracy. The affine based extended model that accounts for time-varying volatility outpaces the other models for fitting the yield curve and produces relatively more accurate 6- and 12-month ahead forecasts, while the standard affine model comes with more precise forecasts for the very short forecast horizons. The study concludes that the standard and affine Nelson–Siegel models have higher forecasting capability than their counterpart EGARCH based models for the short forecast horizons, i.e., 1 month. The EGARCH based extended models have excellent performance for the medium and longer forecast horizons.

Keywords

Latent factors model State-space model Kalman filter EGARCH Forecasting Bond market 

JEL Classification

C32 C53 C51 E43 G12 G17 

Notes

Acknowledgements

We would like to thank the anonymous referees and the Editor for making useful comments to improve this paper.

Supplementary material

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Copyright information

© Springer-Verlag Berlin Heidelberg 2017

Authors and Affiliations

  1. 1.Department of Economics and FinanceInstitute of Business Administration (IBA)KarachiPakistan

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