Chapter 14 Forecasting Interest Rates: An Application of the Stochastic Unit Root and Stochastic Cointegration Frameworks

Abstract

This paper investigates forecasting US Treasury bond and Dollar Eurocurrency rates using the stochastic unit root (STUR) model of Leybourne et al. (1996), and the stochastic cointegration (SC) model of Harris et al. (2002, 2006). Both models have time-varying parameter representations and are conceptually attractive for modelling interest rates as both allow for conditional heteroscedasticity. I find that for many of the series considered STUR and SC models generate statistically significant gains in out-of-sample forecasting accuracy relative to simple orthodox models. The results obtained highlight the usefulness of these extensions and raise some issues for future research.

Citation

Sollis, R. (2008), "Chapter 14 Forecasting Interest Rates: An Application of the Stochastic Unit Root and Stochastic Cointegration Frameworks", Rapach, D.E. and Wohar, M.E. (Ed.) Forecasting in the Presence of Structural Breaks and Model Uncertainty (Frontiers of Economics and Globalization, Vol. 3), Emerald Group Publishing Limited, Leeds, pp. 535-559. https://doi.org/10.1016/S1574-8715(07)00214-X