We extend the class of dynamic factor yield curve models for the inclusion of macro-economic factors. We benefit from recent developments in the dynamic factor literature for extracting the common factors from a large panel of macroeconomic series and for estimating the parameters in the model. We include these factors into a dynamic factor model for the yield curve, in which we model the salient structure of the yield curve by imposing smoothness restrictions on the yield factor loadings via cubic spline functions. We carry out a likelihood-based analysis in which we jointly consider a factor model for the yield curve, a factor model for the macroeconomic series, and their dynamic interactions with the latent dynamic factors. We illustrate the methodology by forecasting the U.S. term structure of interest rates. For this empirical study we use a monthly time series panel of unsmoothed Fama-Bliss zero yields for treasuries of different maturities between 1970 and 2009, which we combine with a macro panel of 110 series over the same sample period. We show that the relation between the macroeconomic factors and yield curve data has an intuitive interpretation, and that there is interdependence between the yield and macroeconomic factors. Finally, we perform an extensive out-of-sample forecasting study. Our main conclusion is that macroeconomic variables can lead to more accurate yield curve forecasts.

Additional Metadata
Keywords Fama-Bliss data set, Kalman filter, maximum likelihoof, yield curv
JEL Time-Series Models; Dynamic Quantile Regressions (jel C32), Model Construction and Estimation (jel C51), Determination of Interest Rates; Term Structure of Interest Rates (jel E43)
Publisher Tinbergen Institute
Persistent URL hdl.handle.net/1765/23262
Series Tinbergen Institute Discussion Paper Series
Journal Discussion paper / Tinbergen Institute
Koopman, S.J, & van der Wel, M. (2011). Forecasting the U.S. Term Structure of Interest Rates using a Macroeconomic Smooth Dynamic Factor Model (No. TI 2011-063/4). Discussion paper / Tinbergen Institute. Tinbergen Institute. Retrieved from http://hdl.handle.net/1765/23262