Forecasts of Inflation and Interest Rates in No-Arbitrage Affine Models

Nikolay Gospodinov and Bin Wei

Working Paper 2016-3
February 2016

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In this paper, we examine the forecasting ability of an affine term structure framework that jointly models the markets for Treasuries, inflation-protected securities, inflation derivatives, and oil future prices based on no-arbitrage restrictions across these markets. On the methodological side, we propose a novel way of incorporating information from these markets into an affine model. On the empirical side, two main findings emerge from our analysis. First, incorporating information from inflation options can often produce more accurate inflation forecasts than those based on the Survey of Professional Forecasters. Second, incorporating oil futures tends to improve short-term inflation and longer-term nominal yield forecasts.

JEL classification: G12, E43, E44, C32

Key words: bond prices, TIPS, inflation derivatives, oil prices, no-arbitrage, affine models, out-of-sample forecasting

The authors thank Todd Clark, Greg Duffee, Mark Fisher, Pat Higgins, Paula Tkac, and the participants at the 2015 System Macro Day-Ahead Conference (Federal Reserve Bank of Cleveland) and the 2016 Econometric Society Winter Meetings for insightful comments. They also thank Hongwei Wu for expert research assistance in parallel computing and Raynold Gilles for data collection. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Nikolay Gospodino, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, nikolay.gospodinov@atl.frb.org, or Bin Wei, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE. Atlanta, GA 30309-4470, bin.wei@atl.frb.org.
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