The effects of conventional and unconventional monetary policy on forecasting the yield curve

Yunjong Eo, Kyu Ho Kang

Research output: Contribution to journalArticle

Abstract

We investigate how conventional and unconventional monetary policies affect the dynamics of the yield curve by assessing the performance of individual yield curve models and their mixtures. Out-of-sample forecasts for U.S. bond yields show that the arbitrage-free Nelson–Siegel model and its mixtures with other models perform well in the period of conventional monetary policy, whereas the random walk model outperforms all the other models in the period of unconventional monetary policy. The diminished role of the no-arbitrage restriction in forecasting the yield curve since 2009 can be attributed to unconventional monetary policy, which resulted in low correlations between short- and long-term bond yields and little variation in the short-term rates. During the period of the maturity extension program in 2011–2012, the superiority of the random walk forecasts is more pronounced, reinforcing our finding that the monetary policy framework affects yield curve forecast accuracy.

Original languageEnglish
Article number103812
JournalJournal of Economic Dynamics and Control
Volume111
DOIs
Publication statusPublished - 2020 Feb

Fingerprint

Monetary Policy
Forecasting
Curve
Forecast
Arbitrage
Random walk
Model
Yield curve
Unconventional monetary policy
Restriction
Bond yields
Monetary policy

Keywords

  • Arbitrage-free term structure model
  • Dynamic Nelson–Siegel model
  • Markov-switching mixture
  • Operation twist
  • Random walk model

ASJC Scopus subject areas

  • Economics and Econometrics
  • Control and Optimization
  • Applied Mathematics

Cite this

The effects of conventional and unconventional monetary policy on forecasting the yield curve. / Eo, Yunjong; Kang, Kyu Ho.

In: Journal of Economic Dynamics and Control, Vol. 111, 103812, 02.2020.

Research output: Contribution to journalArticle

@article{318e8a8005a1498e85a40ed45b3e2cca,
title = "The effects of conventional and unconventional monetary policy on forecasting the yield curve",
abstract = "We investigate how conventional and unconventional monetary policies affect the dynamics of the yield curve by assessing the performance of individual yield curve models and their mixtures. Out-of-sample forecasts for U.S. bond yields show that the arbitrage-free Nelson–Siegel model and its mixtures with other models perform well in the period of conventional monetary policy, whereas the random walk model outperforms all the other models in the period of unconventional monetary policy. The diminished role of the no-arbitrage restriction in forecasting the yield curve since 2009 can be attributed to unconventional monetary policy, which resulted in low correlations between short- and long-term bond yields and little variation in the short-term rates. During the period of the maturity extension program in 2011–2012, the superiority of the random walk forecasts is more pronounced, reinforcing our finding that the monetary policy framework affects yield curve forecast accuracy.",
keywords = "Arbitrage-free term structure model, Dynamic Nelson–Siegel model, Markov-switching mixture, Operation twist, Random walk model",
author = "Yunjong Eo and Kang, {Kyu Ho}",
year = "2020",
month = "2",
doi = "10.1016/j.jedc.2019.103812",
language = "English",
volume = "111",
journal = "Journal of Economic Dynamics and Control",
issn = "0165-1889",
publisher = "Elsevier",

}

TY - JOUR

T1 - The effects of conventional and unconventional monetary policy on forecasting the yield curve

AU - Eo, Yunjong

AU - Kang, Kyu Ho

PY - 2020/2

Y1 - 2020/2

N2 - We investigate how conventional and unconventional monetary policies affect the dynamics of the yield curve by assessing the performance of individual yield curve models and their mixtures. Out-of-sample forecasts for U.S. bond yields show that the arbitrage-free Nelson–Siegel model and its mixtures with other models perform well in the period of conventional monetary policy, whereas the random walk model outperforms all the other models in the period of unconventional monetary policy. The diminished role of the no-arbitrage restriction in forecasting the yield curve since 2009 can be attributed to unconventional monetary policy, which resulted in low correlations between short- and long-term bond yields and little variation in the short-term rates. During the period of the maturity extension program in 2011–2012, the superiority of the random walk forecasts is more pronounced, reinforcing our finding that the monetary policy framework affects yield curve forecast accuracy.

AB - We investigate how conventional and unconventional monetary policies affect the dynamics of the yield curve by assessing the performance of individual yield curve models and their mixtures. Out-of-sample forecasts for U.S. bond yields show that the arbitrage-free Nelson–Siegel model and its mixtures with other models perform well in the period of conventional monetary policy, whereas the random walk model outperforms all the other models in the period of unconventional monetary policy. The diminished role of the no-arbitrage restriction in forecasting the yield curve since 2009 can be attributed to unconventional monetary policy, which resulted in low correlations between short- and long-term bond yields and little variation in the short-term rates. During the period of the maturity extension program in 2011–2012, the superiority of the random walk forecasts is more pronounced, reinforcing our finding that the monetary policy framework affects yield curve forecast accuracy.

KW - Arbitrage-free term structure model

KW - Dynamic Nelson–Siegel model

KW - Markov-switching mixture

KW - Operation twist

KW - Random walk model

UR - http://www.scopus.com/inward/record.url?scp=85076146634&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=85076146634&partnerID=8YFLogxK

U2 - 10.1016/j.jedc.2019.103812

DO - 10.1016/j.jedc.2019.103812

M3 - Article

AN - SCOPUS:85076146634

VL - 111

JO - Journal of Economic Dynamics and Control

JF - Journal of Economic Dynamics and Control

SN - 0165-1889

M1 - 103812

ER -