Forecasting and Finite Sample Performance of Short Rate Models: International Evidence-super-

This paper evaluates the forecasting and finite sample performance of short-term interest rate models in a number of countries. Specifically, we run a series of in-sample and out-of-sample tests for both the conditional mean and volatility of one-factor short rate models, and compare the results to the random walk model. Overall, we find that the out-of-sample forecasting performance of one-factor short rate models is poor, stemming from the inability of the models to accommodate jumps and discontinuities in the time series data. In addition, we perform a series of Monte Carlo analyses similar to Chapman and Pearson to document the finite sample performance of the short rate models when "β"₃ is not restricted to be equal to one. Our results indicate the potential dangers of over-parameterization and highlight the limitations of short-term interest rate models. Copyright (c) International Review of Finance Ltd. 2006.