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78
Forecasting the term structure of government bond yields
 Journal of Econometrics
, 2006
"... Despite powerful advances in yield curve modeling in the last twenty years, comparatively little attention has been paid to the key practical problem of forecasting the yield curve. In this paper we do so. We use neither the noarbitrage approach, which focuses on accurately fitting the cross sectio ..."
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Cited by 275 (16 self)
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Despite powerful advances in yield curve modeling in the last twenty years, comparatively little attention has been paid to the key practical problem of forecasting the yield curve. In this paper we do so. We use neither the noarbitrage approach, which focuses on accurately fitting the cross section of interest rates at any given time but neglects timeseries dynamics, nor the equilibrium approach, which focuses on timeseries dynamics (primarily those of the instantaneous rate) but pays comparatively little attention to fitting the entire cross section at any given time and has been shown to forecast poorly. Instead, we use variations on the NelsonSiegel exponential components framework to model the entire yield curve, periodbyperiod, as a threedimensional parameter evolving dynamically. We show that the three timevarying parameters may be interpreted as factors corresponding to level, slope and curvature, and that they may be estimated with high efficiency. We propose and estimate autoregressive models for the factors, and we show that our models are consistent with a variety of stylized facts regarding the yield curve. We use our models to produce termstructure forecasts at both short and long horizons, with encouraging results. In particular, our forecasts appear much more accurate at long horizons than various standard benchmark forecasts. Finally, we discuss a number of extensions, including generalized duration measures, applications to active bond portfolio management, and arbitragefree specifications. Acknowledgments: The National Science Foundation and the Wharton Financial Institutions Center provided research support. For helpful comments we are grateful to Dave Backus, Rob Bliss, Michael Brandt, Todd Clark, Qiang Dai, Ron Gallant, Mike Gibbons, Da...
Insample or outofsample tests of predictability: which one should we use
 CEPR Discussion Papers 3671, CEPR Discussion Papers
, 2002
"... It is widely known that signiÞcant insample evidence of predictability does not guarantee signiÞcant outofsample predictability. This is often interpreted as an indication that insample evidence is likely to be spurious and should be discounted. In this paper we question this conventional wisdom ..."
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Cited by 163 (15 self)
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It is widely known that signiÞcant insample evidence of predictability does not guarantee signiÞcant outofsample predictability. This is often interpreted as an indication that insample evidence is likely to be spurious and should be discounted. In this paper we question this conventional wisdom. Our analysis shows that neither data mining nor parameter instability is a plausible explanation of the observed tendency of insample tests to reject the no predictability null more often than outofsample tests. We provide an alternative explanation based on the higher power of insample tests of predictability. We conclude that results of insample tests of predictability will typically be more credible than results of outofsample tests.
Using OutofSample Mean Squared Prediction Errors to Test the Martingale Difference Hypothesis
, 2004
"... We consider using outofsample mean squared prediction errors (MSPEs) to evaluate the null that a given series follows a zero mean martingale difference against the alternative that it is linearly predictable. Under the null of no predictability, the population MSPE of the null “no change” model eq ..."
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Cited by 116 (14 self)
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We consider using outofsample mean squared prediction errors (MSPEs) to evaluate the null that a given series follows a zero mean martingale difference against the alternative that it is linearly predictable. Under the null of no predictability, the population MSPE of the null “no change” model equals that of the linear alternative. We show analytically and via simulations that despite this equality, the alternative model’s sample MSPE is expected to be greater than the null’s. For rolling regression estimators of the alternative model’s parameters, we propose and evaluate an asymptotically normal test that properly accounts for the upward shift of the sample MSPE of the alternative model. Our simulations indicate that our proposed procedure works well.
Towards a solution to the puzzles in exchange rate economics: where do we stand?, Canadian
 Journal of Economics
, 2005
"... This paper provides a selective overview of puzzles in exchange rate economics. We begin with the forward bias puzzle: high interest rate currencies appreciate when one might guess that investors would demand higher interest rates on currencies expected to fall in value. We then analyze the purchasi ..."
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Cited by 83 (2 self)
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This paper provides a selective overview of puzzles in exchange rate economics. We begin with the forward bias puzzle: high interest rate currencies appreciate when one might guess that investors would demand higher interest rates on currencies expected to fall in value. We then analyze the purchasing power parity puzzle: the real exchange rate displays no (strong) reversion to a stable longrun equilibrium level. Finally, we cover the exchange rate disconnect puzzle: the lack of a link between the nominal exchange rate and economic fundamentals. For each puzzle, we critically review the literature and speculate on potential solutions. JEL classification: F31.
Purchasing Power Parity and the Real Exchange Rate
, 2002
"... We assess the progress made by the profession in understanding real exchange rate behavior through a selective and critical, but nonetheless expository, review of the literature. Our reading of the literature leads us to the main conclusions that purchasing power parity might be viewed as a valid lo ..."
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Cited by 62 (3 self)
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We assess the progress made by the profession in understanding real exchange rate behavior through a selective and critical, but nonetheless expository, review of the literature. Our reading of the literature leads us to the main conclusions that purchasing power parity might be viewed as a valid longrun international parity condition when applied to bilateral exchange rates obtaining among major industrialized countries, and that mean reversion in real exchange rates displays significant nonlinearities. However, further work investigating the effects of real shocks on the longrun equilibrium level also seems warranted.
Monetary policy and long horizon uncovered interest parity
 IMF Staff Papers
, 2004
"... Uncovered interest parity (UIP) has been almost universally rejected in studies of exchange rate movements. In contrast to previous studies, which have used shorthorizon data, we test UIP using interest rates on longermaturity bonds for the Group of Seven countries. These longhorizon regressions y ..."
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Cited by 54 (7 self)
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Uncovered interest parity (UIP) has been almost universally rejected in studies of exchange rate movements. In contrast to previous studies, which have used shorthorizon data, we test UIP using interest rates on longermaturity bonds for the Group of Seven countries. These longhorizon regressions yield much more support for UIP—all of the coefficients on interest differentials are of the correct sign, and almost all are closer to the UIP value of unity than to zero. We then use a macroeconomic model to explain the differences between the short and longhorizon results. Regressions run on modelgenerated data replicate the important regularities in the actual data, including the sharp differences between short and longhorizon parameters. In the short run, the failure of UIP results from the interaction of stochastic exchange market shocks with endogenous monetary policy reactions. In the long run, in contrast, exchange rate movements are driven by the “fundamental, ” leading to a relationship between interest rates and exchange rates that is more consistent with UIP. [JEL F21, F31, F41] Few propositions are more widely accepted in international economics than that uncovered interest parity (UIP) is at best useless—or at worst perverse—
Exchange Rates and Fundamentals: Evidence on the Economic Value of Predictability
, 2004
"... A major puzzle in international finance is the welldocumented inability of models based on monetary fundamentals to produce better outofsample forecasts of the nominal exchange rate than a naive random walk. While this literature has generally employed statistical measures of forecast accuracy, w ..."
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Cited by 53 (7 self)
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A major puzzle in international finance is the welldocumented inability of models based on monetary fundamentals to produce better outofsample forecasts of the nominal exchange rate than a naive random walk. While this literature has generally employed statistical measures of forecast accuracy, we investigate whether there is any economic value to the predictive power of monetary fundamentals for the exchange rate. We find that, in the context of a simple asset allocation problem, the economic value of exchange rate forecasts from a fundamentals model can be greater than the economic value of random walk forecasts across a range of horizons.
The predictive content of the output gap for inflation: resolving insample and outofsample evidence
 Journal of Money, Credit, and Banking
, 2006
"... Todd Clark is vice president and economist at the Federal Reserve Bank of Kansas City and ..."
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Cited by 38 (5 self)
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Todd Clark is vice president and economist at the Federal Reserve Bank of Kansas City and
Evaluating direct multistep forecasts
 Econometric Reviews
, 2005
"... Todd E. Clark is a vice president and economist at the Federal Reserve Bank of Kansas City. Michael W. McCracken is an assistant professor of economics at the University of MissouriColumbia. Earlier versions of this paper were titled “Evaluating LongHorizon Forecasts. ” The authors gratefully ack ..."
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Cited by 36 (6 self)
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Todd E. Clark is a vice president and economist at the Federal Reserve Bank of Kansas City. Michael W. McCracken is an assistant professor of economics at the University of MissouriColumbia. Earlier versions of this paper were titled “Evaluating LongHorizon Forecasts. ” The authors gratefully acknowledge the helpful comments of Lutz Kilian, David Rapach, Ken West, seminar participants at the Federal Reserve Bank of Kansas City, and participants at the 2001 MEG meetings. McCracken thanks LSU for financial support during work on a substantial portion of this paper. The views expressed herein are solely those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Kansas City or the Federal Reserve System.
Volatility Comovement: A Multifrequency Approach
, 2004
"... We implement a multifrequency volatility decomposition of three exchange rates and show that components with similar durations are strongly correlated across series. This motivates a bivariate extension of the MarkovSwitching Multifractal (MSM) introduced in Calvet and Fisher (2001, 2004). Bivariat ..."
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Cited by 33 (4 self)
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We implement a multifrequency volatility decomposition of three exchange rates and show that components with similar durations are strongly correlated across series. This motivates a bivariate extension of the MarkovSwitching Multifractal (MSM) introduced in Calvet and Fisher (2001, 2004). Bivariate MSM is a stochastic volatility model with a closedform likelihood. Estimation can proceed by ML for state spaces of moderate size, and by simulated likelihood via a particle filter in highdimensional cases. We estimate the model and confirm its main assumptions in likelihood ratio tests. Bivariate MSM compares favorably to a standard multivariate GARCH both in and outofsample. We extend the model to multivariate settings with a potentially large number of assets by proposing a parsimonious multifrequency factor structure.