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Forecasting and Finite Sample Performance of Short Rate Models: International Evidence

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  • SIRIMON TREEPONGKARUNA

Abstract

This paper evaluates the forecasting and finite sample performance of short‐term interest rate models in a number of countries. Specifically, we run a series of in‐sample and out‐of‐sample tests for both the conditional mean and volatility of one‐factor short rate models, and compare the results to the random walk model. Overall, we find that the out‐of‐sample forecasting performance of one‐factor short rate models is poor, stemming from the inability of the models to accommodate jumps and discontinuities in the time series data. In addition, we perform a series of Monte Carlo analyses similar to Chapman and Pearson to document the finite sample performance of the short rate models when β3 is not restricted to be equal to one. Our results indicate the potential dangers of over‐parameterization and highlight the limitations of short‐term interest rate models.

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  • Sirimon Treepongkaruna, 2005. "Forecasting and Finite Sample Performance of Short Rate Models: International Evidence," International Review of Finance, International Review of Finance Ltd., vol. 5(3‐4), pages 175-197, September.
    • Handle: RePEc:bla:irvfin:v:5:y:2005:i:3-4:p:175-197
    DOI: 10.1111/j.1468-2443.2006.00056.x
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    Cited by:

    1. Robert Faff & Sirimon Treepongkaruna, 2013. "A re-examination of the empirical performance of the Longstaff and Schwartz two-factor term structure model using real yield data," Australian Journal of Management, Australian School of Business, vol. 38(2), pages 333-352, August.
    2. Christopher M. Bilson & Timothy J. Brailsford & Luke J. Sullivan & Sirimon Treepongkaruna, 2008. "Pricing Bonds in the Australian Market," Australian Journal of Management, Australian School of Business, vol. 33(1), pages 123-143, June.

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