Multi-Factor Dynamic Modelling and Forecasting of Interest Rates and Equity Markets

In this thesis, several theoretical specifications and estimation techniques are employed towards the dynamic modelling and forecasting of the term structure of interest rates, both independently and in conjunction with equity markets. The first empirical investigation is motivated by the recent call for richer specifications following the global financial crisis of 2007-2009. In that regard, several existing multi-factor continuous-time models are extended to four and five factors to assess the benefit of richer models. The Gaussian estimation methods for dynamic Continuous-Time models yield insightful comparative results concerning the two different segments of the yield curve. The dynamics of the more volatile short-end of the yield curve are best explained by the most flexible models which consistently outperform all the other less complex models in terms of both in-sample and out-of-sample performance. For the long-end flatter segment, the benchmark discrete-time parsimonious models seem hard to beat, while the addition of extra factors has a minimal benefit in terms of forecasting performance. In a second empirical study, the term structures of three Scandinavian countries are modelled using multi-latent-factor models. The empirical results produced by Kalman filter estimation method indicate that the three-factor specification captures most of the changes over time in the shape of the yield curve for Denmark and Norway, while for Sweden the statistical tests do not reject the two-factor model against the three-factor formulation. Finally, the third investigation brings new empirical evidence of the impact of the 2007-2009 financial crisis on the return and volatility linkages between the U.S. - the country where the shock originated and other major economies using a multivariate methodology for the simultaneous modelling of interest rates and equity markets. During the global financial crisis of 2007-2009 the financial markets around the world have communicated through a more complex network of information transmission routes. The channels with most intensity of information transmission were the indirect international ones, bringing new evidence of the importance of this type of routes that has previously been investigated very little in the spillovers literatur

Gaussian estimation and forecasting of the U.K. yield curve with multi-factor continuous-time models

In this paper we will estimate the term structure of daily U.K. interest rates using a range of more flexible continuous-time models. A multivariate framework is employed for the dynamic estimation and forecasting of four classic models over the eventful period of 2000–2013. The extensions are applied in two stages to four- and five-factor formulations, allowing us to assess the potential benefit of gradually increasing the model-flexibility. The Gaussian estimation methods for dynamic continuous-time models yield insightful comparative results concerning the two different segments of the yield curve, short- and long-term, respectively. In terms of in-sample performance the newly extended multi-factor general model is superior to all other restricted models. When compared to benchmark discrete-time models, the out-of-sample performance of the extended continuous-time models seems to be consistently superior with regards to the short-term segment of the yield curve

The Interconnectedness Between Green Finance Indexes and Other Important Financial Variables

In this article, the authors explore the degree of interconnectedness between stock indexes adjusted for green revenues of companies from major economies and various other important macroeconomic and financial variables. For the most complex model considered, the analysis indicates that the green revenue index for China is directly related to the green revenue indexes of the US, Europe and UK, only to Apple but not to Microsoft, and to none of the macroeconomic variables included in the study. The analysis shows that gold price risk is orthogonal on climate change risk. Oil prices and international bond prices seem to impact the green revenues of companies in China and the UK only through the related green revenues of the intermediary companies in the US and Europe

The interconnectedness between green finance indexes and other important financial variables

In this article, the authors explore the degree of interconnectedness between stock indexes adjusted for green revenues of companies from major economies and various other important macroeconomic and financial variables. For the most complex model considered, the analysis indicates that the green revenue index for China is directly related to the green revenue indexes of the US, Europe and UK, only to Apple but not to Microsoft, and to none of the macroeconomic variables included in the study. The analysis shows that gold price risk is orthogonal on climate change risk. Oil prices and international bond prices seem to impact the green revenues of companies in China and the UK only through the related green revenues of the intermediary companies in the US and Europe

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

The impact of corporate social responsibility on corporate financial performance and credit ratings in Japan

We investigate the impact of companies’ sustainability efforts on their corporate financial performance (CFP) and credit ratings in Japan, based on a new proxy for corporate social responsibility (CSR) − Sustainalytics’ quantitative Environment, Social and Governance (ESG) ratings. We find weak evidence of negative impact of ESG scores (on an aggregated basis and disaggregated basis) on several accounting measures of CFP. Our quantile regression results reveal non-linear pattern across the quantiles, with CSR effects intensifying at the extremal quantiles. However, we find a weak positive relationship between ESG and stock market-based measures, as well as between ESG and credit ratings. Our findings suggest that investors, credit rating agencies (CRAs) and regulators should differentiate between the three types of ESG screening as they interact and contribute in their specific way to the aggregate ESG effect

A Comparison of Multi-Factor Term Structure Models for Interbank Rates

In this paper, we present a robust predictive comparison of several continuous-time multi-factor models in the context of interbank rates. Recognizing the specific dynamics of the short-term segment of the yield curve, we examine the U.S. money market by extending two continuous-time frameworks with different factor structures, the Chan-Karolyi-Longstaff-Sanders (CKLS) model and the arbitrage-free dynamic Nelson-Siegel (AFDNS) model. A battery of formal forecasting accuracy tests is employed to select a subset of superior predictive models. Despite a better goodness-of-fit measure, additional factors improve the forecasting performance only for the CKLS family. With implications for monetary policy formulation, we found evidence of two separate maturity segments as the three-factor AFDNS and the five-factor CKLS models outperform parsimonious benchmarks in predicting the interbank rates for very short maturities. Our comparative forecasting results are re-confirmed with stronger out-of-sample performance for the five-factor CKLS model when the post global financial crisis sub-sample is analyzed

Not Everyone is a Follower: The Behaviour of Interest Rate and Equity Markets within Major Economies relative to the US

Using a multi-factor continuous-time model we study the impact of the global financial crisis on the information transmission mechanism between interest rate and equity markets in the US and each of the four major economies (UK, Japan, Germany and Canada). The exchange of information through the return channel shows that the equity markets communicate differently with the short- and long-term interest markets: the linkages between the equity and moneymarkets follow similar patterns across all four major economies, while the feedbacks between the returns on equity and bond markets suggest country-specific relationships with the US The level of interdependence is higher between the equity and long-term bond markets, while within the money-markets context there is evidence of the flight-to-quality phenomenon