Citation

Discussion Paper Details

Please find the details for DP9848 in an easy to copy and paste format below:

Full Details   |   Bibliographic Reference

Full Details

Title: No Arbitrage Priors, Drifting Volatilities, and the Term Structure of Interest Rates

Author(s): Andrea Carriero, Todd Clark and Massimiliano Marcellino

Publication Date: March 2014

Keyword(s): density forecasting, no arbitrage, stochastic volatility and Term structure

Programme Area(s): International Macroeconomics

Abstract: We propose a method to produce density forecasts of the term structure of government bond yields that accounts for (i) the possible mispecification of an underlying Gaussian Affine Term Structure Model (GATSM) and (ii) the time varying volatility of interest rates. For this, we derive a Bayesian prior from a GATSM and use it to estimate the coefficients of a BVAR for the term structure, specifying a common, multiplicative, time varying volatility for the VAR disturbances. Results based on U.S. data show that this method significantly improves the precision of point and density forecasts of the term structure. While this paper focuses on term structure modelling, the proposed method can be applied for a wide range of alternative models, including DSGE models, and is a generalization of the method of Del Negro and Schorfheide (2004) to VARs featuring drifting volatilities. The method also generalizes the model of Giannone et al. (2012), by specifying hierarchically not only the prior variance but also the prior mean of the VAR coefficients. Our results show that both time variation in volatilities, and a hierarchical specification for the prior means, improve model fit and forecasting performance.

For full details and related downloads, please visit: https://cepr.org/active/publications/discussion_papers/dp.php?dpno=9848

Bibliographic Reference

Carriero, A, Clark, T and Marcellino, M. 2014. 'No Arbitrage Priors, Drifting Volatilities, and the Term Structure of Interest Rates'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=9848