Forecasting the Term Structures of Treasury and Corporate Yields : Dynamic Nelson-Siegel Models Evaluation

We extend Diebold and Li's dynamic Nelson-Siegel three-factor model to a broader empirical prospective by including the evaluation of state-space approach, and using nine different ratings of corporate bonds. We find that the dynamic Nelson-Siegel factor AR(1) model outperforms other competitors on the out-of-sample forecast accuracy, especially on the investment-grade bonds in the short-term forecast horizon and on the high-yield bonds in the long-term forecast horizon. The dynamic Nelson-Siegel factor state-space model, however, becomes appealing on the high-yield bonds in the short-term forecast horizon, in which the factor dynamics are more likely time-varying and the parameter instability is more probable in the model specification