Forecasting CanadianShort-Term Interest Rates

Thomas Thorn

Motivation

• Forecasting S/T interest rates is important for central banks, individual & private investors

• Existing papers apply different methodologies on different sets of data: makes it difficult to compare

Data

• CANSIM: 3/6 month T-bills; 1-3 year, 3-5 year, 5-10 year and 10+ year average bond yields

• Given monthly observations, convert to quarterly by using March, June, September and December observations

Data

• To back out spot yield curve:

where c = coupon rate, pt=premium paid

• Problem: Gvt of Canada coupon rates are not available on CANSIM or from Bank of Canada

If I remember correctly these are just bond yield averages available from the Bank of Canada (they should be on CANSIM). Because these are averages I assumed that at each point in time the "bond" in question was a par bond (so YTM = coupon).

What? I’m not sure that’s right..

Data

• If bonds are sold at par, pt = 0, so:

• However, this will be a complex number when ‘n’ is even

• Couldn’t figure out what was going on: skipped using forward rates

Results – Table 1

• Table 1: ADFs galore: T-bill rate

Results – Table 1

• Table 1: ADFs galore: Long rate

Results – Table 1

• Table 1: Cointegration

Results – Table 1

• Table 1: Cointegration

Results – Table 1

• Table 1: Cointegration

Results – Table 2

Results – Table 2

Results – Table 2

Results – Table 3

Results – Table 3

Results – Table 41. the sample size is initialized to range from 1951Q1 to

1962Q4. 2. a regression is estimated3. a forecast is made for 1 quarter ahead4. the forecasts error is determined and saved5. the sample size is increased by a single quarter, and the

program returns to step (2) until 1992Q36. RMSE and MAE are calculated

Results – Table 4

Failures

• I couldn’t replicate any of the BG p-values

• Systematic difference between our results

• I couldn’t back out spot yield curve