Testing the Forecasting Ability of Multi-Factor Models on Non-US Interbank Rates

We examine the forecasting performance of continuous time multi-factor models for the term structure of interbank rates in UK, Europe and Japan in comparison with other parsimonious models. We employ two general dynamic frameworks with different factor structures, the generalized Chan-Karolyi-Longstaff-Sanders family of models and the arbitrage-free dynamic Nelson-Siegel family of models. Applying a battery of accuracy measures and a range of formal tests of forecasting superiority, we provide evidence that extended multi-factor models have good out-of-sample forecasting performance of the short segment of the yield curve. However, for the euro and partially for the yen the random walk forecasts pass various tests consistently, indicating a higher level of market efficiency compared to the sterling pound interbank market