Estimating Term Structure of Interest Rates: Neural Network Vs one Factor Parametric Models

Fathi Abid, Mona Ben Salah
2002 Social Science Research Network  
The aim of this paper is twofold; first we concentrate on the work of Vasicek (1977) and Cox, Ingersoll and Ross (1985) . We examine and test empirically each model and discuss its performance in predicting the term structure of interest rates using a parametric estimating approach GMM (Generalized Moments Method). Second we estimate the term structure of interest rate dynamics using a nonparametric approach ANN (Artificial Neural Network). Two neural network models are performed. The first
more » ... rmed. The first model uses spreads between interest rates of 10 different maturities as the only explanatory variable of interest rate changes. The second model introduces two factors, spreads and interest rates' levels. Using historical U.S. Treasury bill rates and Treasury bond yields, we compare the ability of each model to predict the term structure of interest rates. Data are daily and cover the period from 3 January 1995 to 29 December 2000. Results suggest that neural network, Vasicek (1977) and Cox, Ingersoll and Ross (1985) models generate different yield curves. Neural network models outperform the parametric standard models. The most successful forecast is obtained with a two factors neural network model.
doi:10.2139/ssrn.313561 fatcat:644hfmbwwbeqlegnb4x7ssgrq4