Functional dynamic factor models with application to yield curve forecasting

DOI10.1214/12-AOAS551zbMATH Open1454.62302arXiv1209.6172OpenAlexW2029865151MaRDI QIDQ714342FDOQ714342

Jianhua Z. Huang, Haipeng Shen, Spencer Hays

Publication date: 21 October 2012

Published in: The Annals of Applied Statistics (Search for Journal in Brave)

Abstract: Accurate forecasting of zero coupon bond yields for a continuum of maturities is paramount to bond portfolio management and derivative security pricing. Yet a universal model for yield curve forecasting has been elusive, and prior attempts often resulted in a trade-off between goodness of fit and consistency with economic theory. To address this, herein we propose a novel formulation which connects the dynamic factor model (DFM) framework with concepts from functional data analysis: a DFM with functional factor loading curves. This results in a model capable of forecasting functional time series. Further, in the yield curve context we show that the model retains economic interpretation. Model estimation is achieved through an expectation-maximization algorithm, where the time series parameters and factor loading curves are simultaneously estimated in a single step. Efficient computing is implemented and a data-driven smoothing parameter is nicely incorporated. We show that our model performs very well on forecasting actual yield data compared with existing approaches, especially in regard to profit-based assessment for an innovative trading exercise. We further illustrate the viability of our model to applications outside of yield forecasting.

Full work available at URL: https://arxiv.org/abs/1209.6172

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zbMATH Keywords

functional data analysiscross-validationexpectation maximization algorithmnatural cubic splinesroughness penalty

Mathematics Subject Classification ID

Factor analysis and principal components; correspondence analysis (62H25) Applications of statistics to actuarial sciences and financial mathematics (62P05) Functional data analysis (62R10) Interest rates, asset pricing, etc. (stochastic models) (91G30)

Cites Work

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Cited In (23)

• Long-Range Dependent Curve Time Series
• Tempered functional time series
• KPSS test for functional time series
• Time series of functional data with application to yield curves
• Testing stationarity of functional time series
• Dependent functional data
• Functional lagged regression with sparse noisy observations
• Structured prior distributions for the covariance matrix in latent factor models
• Functional principal component analysis for partially observed elliptical process
• Testing for periodicity in functional time series
• Inference in functional factor models with applications to yield curves
• Factor models for high‐dimensional functional time series I: Representation results
• Fractionally integrated curve time series with cointegration
• Dynamic regression models for time-ordered functional data
• Nonparametric estimation of functional dynamic factor model
• Segmental dynamic factor analysis for time series of curves
• Intraday forecasts of a volatility index: functional time series methods with dynamic updating
• Estimation of a nonparametric model for bond prices from cross-section and time series information
• Modeling and forecasting electricity spot prices: a functional data perspective
• Locally stationary functional time series
• Functional dynamic factor models with application to yield curve forecasting
• Functional Autoregression for Sparsely Sampled Data
• Modeling Nelson–Siegel Yield Curve Using Bayesian Approach

Uses Software

• forecast
• fda (R)

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