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Andrea Carriero, Queen Mary University Print
Thursday, 14 March 2013, 12:15 - 13:15

Andrea Carriero, Queen Mary University

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

Abstract: In this paper we propose a method to produce density forecasts of the term structure of government bond yields which takes into account (i) the possible mispecification of an underlying No Arbitrage model and (ii) the time varying volatility of interest rates. In order to do so we derive a prior from a No Arbitrage model, and we specify 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 density  forecasts of the term structure.

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