Title: Modelling and forecasting international interest rate spreads: UK, Germany, Japan and the USA

Authors: Orla Gough; K. Ben Nowman; Stefan Van Dellen

Addresses: Department of Accounting, Finance and Governance, Westminster Business School, 35 Marylebone Road, London NW1 5 LS, UK ' Department of Accounting, Finance and Governance, Westminster Business School, 35 Marylebone Road, London NW1 5 LS, UK ' Department of Accounting, Finance and Governance, Westminster Business School, 35 Marylebone Road, London NW1 5 LS, UK

Abstract: The interest rate spread is of importance to policymakers and finance professionals in asset allocation and is a common measure of financial market stress. In this paper, we model and forecast the interest rate spreads for a number of countries using two well-known continuous time models and discrete time ARMA and ARFIMA models. We use monthly and weekly data which cover the recent global financial market crisis of 2007-2009 for Germany, Japan, UK and the USA. We find that the Merton's continuous-time model outperforms all other model specifications in terms of the mean of the forecast errors, MAPE and RMSE.

Keywords: continuous time; Gaussian estimation; ARMA; ARIMA; ARFIMA; time series; forecasting; modelling; UK; United Kingdom; Germany; Japan; USA; United States; risk management; international interest rates; interest rate spreads; forecast errors.

DOI: 10.1504/IJFERM.2014.065648

International Journal of Financial Engineering and Risk Management, 2014 Vol.1 No.4, pp.309 - 333

Received: 08 Apr 2013
Accepted: 03 Nov 2013

Published online: 31 Oct 2014 *

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