the forward spread in thailand

Thitirat Sittakaradej

The Forward Spread in Thailand: Its Predictive Power and Key Influencing Factors

Term structure of interest rate

Studied by

Goodfriend(1998) and Kim

and Orphanides (2007),

the term structure of

interest rate serves a

vital role as a precise

source of information

on public expectations

and responses to the

shifts in the economy.

1. Introduction

Expectation Hypothesis (EH)

Expectation hypothesis (EH) under the term structure

of interest rate explains the connection between the

interest rates and the maturities of investment though

the forward rates.

where is the spot interest rate on n-year to maturity of zero-coupon bond at time t

is the forward interest rate on m-year to maturity of zero-coupon bond at time t

Therefore, with EH, the term structure of interest

rate provides the best forecast of future spot rates.

Case of two time periods :

Prior studies

The term structure of

interest rate contains

little information

about future spot

rates and the study

leads to a conclusion

of weak predictive

power overtime.

(See Fama and Bliss, 1987; Mishkin, 1988; Davis, 1996).

from Germany from U.S.A.

The forward spreads are

very powerful predictors

of short-term interest rate

changes. With less

predictive power for

long-term rates, both the

signs and the coefficient

estimates are still

coherent with EH.

(See Boero and Torricelli, 1999).



little information

about future spot

rates and the study


of weak predictive

power overtime.




little information

about future spot

rates and the study


of weak predictive

power overtime.


The forward spreads are

very powerful predictors

of short-term interest rate

changes. With less

predictive power for

long-term rates, both the

signs and the coefficient

estimates are still

coherent with EH.

(See Boero and Torricelli, 1999).

2. Objective

This paper aims to study the

predictive power of the forward

rate from the expectation hypothesis

(EH) under the term structure of

interest rate in forecasting future

spot rate from the market, and

examine the key factors influencing

this forward spread.

3. Forward Spread in Thailand

Data set • The time period is 2002-2012.

• Focus on yields of zero-coupon government bonds

with 1 year, 3 years and 5 years time to maturity.

• Other monthly data include policy rate, Manufacturing

Production Index (MPI), export value, amount of capital inflow,

number of working hour, NEER and inflation rate.

Methodology Step 1 : Calculate the forward spread from expectation

hypothesis under the term structure of interest rate

Step 2 : (Model1) Test the predictive power of the forward spread

Step 3 : (Model2) Determine the key factors influencing the forward spread

Model 1 : Predictive power of the forward spread

The forward spread would be a powerful predictor of future spot rate if the value of β is 1.

where is the spot interest rate on n-year to maturity of zero-coupon bond at time t is the forward interest rate on m-year to maturity of zero-coupon bond at time t and is ith exogenous variable including policy rate, inflation and export value at time t

Case of two time periods at time = 0 :

Yield spread (ysp(n))

Forward spread (fsp(n))

Model1 : Result (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)

OLS OLS FGLS ARCH(1) GARCH(2,1) OLS FGLS ARCH(1) OLS FGLS ARCH(1)

VARIABLES ysp1 ysp1 ysp1 ysp1 ysp1 ysp3 ysp3 ysp3 ysp5 ysp5 ysp5

fsp1 1.159*** 1.174*** 1.174*** 1.034*** 0.748***

(0.223) (0.231) (0.222) (0.0944) (0.0365)

fsp3 -1.135*** -1.135*** -1.251***

(0.257) (0.205) (0.141)

fsp5 -2.741*** -2.741*** -3.001***

(0.340) (0.321) (0.169)

dpolrate 0.942 0.942 -0.385 -0.497** 1.101* 1.101** -0.147 0.616 0.616 -0.0270

(0.697) (0.625) (0.271) (0.238) (0.625) (0.525) (0.304) (0.528) (0.429) (0.253)

infla -0.170*** -0.170** 0.0448* 0.00409 -0.0613 -0.0613 -0.101*** 0.00460 0.00460 -0.0345

(0.0535) (0.0736) (0.0260) (0.0127) (0.0546) (0.0468) (0.0355) (0.0436) (0.0353) (0.0249)

export -1.22e-06 -1.22e-06 -8.64e-08 -4.24e-08 -1.45e-06 -1.45e-06 1.60e-06** -4.06e-06*** -4.06e-06*** -6.19e-07

(1.02e-06) (9.10e-07) (4.06e-07) (2.69e-07) (9.64e-07) (8.77e-07) (6.29e-07) (8.66e-07) (7.77e-07) (5.02e-07)

Constant -0.611*** 0.348 0.348 -0.538*** -0.427*** 1.575*** 1.575*** 0.0123 3.185*** 3.185*** 1.598***

(0.170) (0.414) (0.433) (0.207) (0.121) (0.394) (0.432) (0.256) (0.426) (0.412) (0.246)

Observations 120 119 119 119 119 119 119 119 119 119 119

Adjusted

R-squared 0.180 0.262 0.262 . . 0.216 0.216 . 0.410 0.410 .

fwdsp=1 0.477 0.452 0.434 0.720 0 0 0 0 0 0 0

CI(lb) 0.718 0.717 0.734 0.849 0.676 -1.644 -1.541 -1.528 -3.413 -3.376 -3.333

CI(ub) 1.600 1.632 1.614 1.219 0.819 -0.625 -0.729 -0.974 -2.068 -2.106 -2.669

BIC 377.4 373.6 373.6 307.1 306.7 360.3 360.3 302.4 315.3 315.3 251.8

Standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1

Time to maturity : 1 -4

-20

2

0 .5 1 1.5 2

ysp1 Fitted values

Slope = 1

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)



fsp1 1.159*** 1.174*** 1.174*** 1.034*** 0.748***

(0.223) (0.231) (0.222) (0.0944) (0.0365)

fsp3

fsp5

dpolrate 0.942 0.942 -0.385 -0.497**

(0.697) (0.625) (0.271) (0.238)

infla -0.170*** -0.170** 0.0448* 0.00409

(0.0535) (0.0736) (0.0260) (0.0127)

export -1.22e-06 -1.22e-06 -8.64e-08 -4.24e-08

(1.02e-06) (9.10e-07) (4.06e-07) (2.69e-07)

Constant -0.611*** 0.348 0.348 -0.538*** -0.427***

(0.170) (0.414) (0.433) (0.207) (0.121)

Observations 120 119 119 119 119

Adjusted R-squared 0.180 0.262 0.262 . .

fwdsp=1 0.477 0.452 0.434 0.720 0

CI(lb) 0.718 0.717 0.734 0.849 0.676

CI(ub) 1.600 1.632 1.614 1.219 0.819

BIC 377.4 373.6 373.6 307.1 306.7


*** p<0.01, ** p<0.05, * p<0.1

β is 1 and close to 1.

Time to maturity : 1 Time to maturity : 1

For bond with 1 year

time to maturity,

forward spread

predicts future yield spread well .

Time to maturity : 3

-2-1

01

23

0 .5 1 1.5 2

ysp3 Fitted values

Slope = 1

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)



fsp1 1.159*** 1.098*** 1.098*** 1.004*** 0.740***

(0.223) (0.224) (0.214) (0.0881) (0.0449)

fsp3 -1.135*** -1.135*** -1.251***

(0.257) (0.205) (0.141)

fsp5 -2.770*** -2.770*** -2.999***

(0.331) (0.315) (0.150)

gpolrate 4.341** 4.341** -0.812 -1.229*** 1.101* 1.101** -0.147 2.485* 2.485** -0.276

(1.714) (1.806) (0.614) (0.379) (0.625) (0.525) (0.304) (1.307) (1.198) (0.669)

infla -0.187*** -0.187*** 0.0417* 0.00168 -0.0613 -0.0613 -0.101*** -0.00222 -0.00222 -0.0346

(0.0511) (0.0703) (0.0242) (0.0133) (0.0546) (0.0468) (0.0355) (0.0426) (0.0360) (0.0245)

export -1.37e-06 -1.37e-06 -1.47e-07 -9.67e-08 -1.45e-06 -1.45e-06 1.60e-06**

-4.18e-

06***

-4.18e-

06*** -5.47e-07

(1.00e-

06)

(9.15e-

07)

(4.25e-

07) (3.21e-07) (9.64e-07) (8.77e-07) (6.29e-07) (8.61e-07) (7.91e-07) (4.91e-07)

Constant -0.611*** 0.484 0.484 -0.484** -0.391*** 1.575*** 1.575*** 0.0123 3.262*** 3.262*** 1.565***

(0.170) (0.407) (0.431) (0.206) (0.133) (0.394) (0.432) (0.256) (0.419) (0.409) (0.228)

Observations 120 119 119 119 119 119 119 119 119 119 119

Adjusted R-squared 0.180 0.290 0.290 . . 0.216 0.216 . 0.421 0.421 .

fwdsp=1 0.477 0.661 0.647 0.960 0 0 0 0 0 0 0

CI(lb) 0.718 0.655 0.674 0.832 0.652 -1.644 -1.541 -1.528 -3.426 -3.393 -3.292

CI(ub) 1.600 1.542 1.522 1.177 0.828 -0.625 -0.729 -0.974 -2.113 -2.146 -2.705

BIC 377.4 369.0 369.0 308.1 307.6 360.3 360.3 302.4 313.0 313.0 251.6


*** p<0.01, ** p<0.05, * p<0.1

β is less than 1.


Time to maturity : 5 -2

-10

12

0 .5 1 1.5 2

ysp5 Fitted values

Slope = 1

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)



fsp1 1.159*** 1.098*** 1.098*** 1.004*** 0.740***

(0.223) (0.224) (0.214) (0.0881) (0.0449)

fsp3 -1.138*** -1.138*** -1.315***

(0.251) (0.201) (0.133)

fsp5 -2.741*** -2.741*** -3.001***

(0.340) (0.321) (0.169)

gpolrate 4.341** 4.341** -0.812 -1.229*** 4.073*** 4.073*** -0.926 0.616 0.616 -0.0270

(1.714) (1.806) (0.614) (0.379) (1.546) (1.509) (0.684) (0.528) (0.429) (0.253)

infla -0.187*** -0.187*** 0.0417* 0.00168 -0.0713 -0.0713 -0.0837** 0.00460 0.00460 -0.0345

(0.0511) (0.0703) (0.0242) (0.0133) (0.0532) (0.0473) (0.0336) (0.0436) (0.0353) (0.0249)

export -1.37e-06 -1.37e-06 -1.47e-07 -9.67e-08

-1.60e-

06*

-1.60e-

06*

2.06e-

06*** -4.06e-06*** -4.06e-06*** -6.19e-07

(1.00e-

06)

(9.15e-

07)

(4.25e-

07) (3.21e-07) (9.51e-07) (8.99e-07) (5.82e-07) (8.66e-07) (7.77e-07) (5.02e-07)

Constant -0.611*** 0.484 0.484 -0.484** -0.391*** 1.654*** 1.654*** -0.168 3.185*** 3.185*** 1.598***

(0.170) (0.407) (0.431) (0.206) (0.133) (0.388) (0.435) (0.234) (0.426) (0.412) (0.246)

Observations 120 119 119 119 119 119 119 119 119 119 119

Adjusted R-squared 0.180 0.290 0.290 . . 0.241 0.241 . 0.410 0.410 .

fwdsp=1 0.477 0.661 0.647 0.960 0 0 0 0 0 0 0

CI(lb) 0.718 0.655 0.674 0.832 0.652 -1.634 -1.536 -1.576 -3.413 -3.376 -3.333

CI(ub) 1.600 1.542 1.522 1.177 0.828 -0.641 -0.739 -1.055 -2.068 -2.106 -2.669

BIC 377.4 369.0 369.0 308.1 307.6 356.5 356.5 301.4 315.3 315.3 251.8


*** p<0.01, ** p<0.05, * p<0.1

β is a lot less than 1.


For bonds with higher time

to maturity, both signs and

coefficient estimates of the

impacts show low or no predictive power.

where is the spot interest rate on n-year to maturity of zero-coupon bond at time t is the forward interest rate on m-year to maturity of zero-coupon bond at time t is policy rate at time t and is ith variable including MPI, export value, amount of capital inflow, working hours,

NEER and inflation rate at time t

Model 2 : Key Influencing Factors of the Forward Spread

The changes in factors affect the forward spread

when the coefficient estimates are significant.

Forward spread (fsp(n))

Model2 : Result

(1) (2) (3) (4) (5) (6) (7) (8)

VARIABLES fsp1 fsp1 fsp1 fsp1 fsp1 fsp1 fsp3 fsp5

1. Monetary Policy

dpolrate 1.047*** 0.882*** 0.865*** 0.756*** 0.764*** 0.742*** 0.761*** 0.398***

(0.230) (0.243) (0.258) (0.283) (0.283) (0.281) (0.250) (0.151)

2. Business Cycle

ympi 0.768** 0.716* 0.765* 0.882* 0.864* -0.288 0.221

(0.346) (0.428) (0.430) (0.448) (0.444) (0.396) (0.239)

yexport 0.0950 0.0464 -0.0764 -0.188 0.579 0.194

(0.460) (0.461) (0.479) (0.480) (0.427) (0.258)

ykinflow 0.0510 0.0445 0.0402 0.0355 0.0100

(0.0374) (0.0381) (0.0378) (0.0337) (0.0204)

ywhour -0.591 -0.382 -0.662 1.537 1.125

(2.791) (2.801) (2.784) (2.480) (1.499)

yneer -1.070 -0.998 3.784*** 0.923

(1.124) (1.116) (0.994) (0.601)

3. Inflation

dinfla 0.0896 -0.0208 0.000447

(0.0551) (0.0491) (0.0296)

Constant 0.600*** 0.570*** 0.563*** 0.543*** 0.564*** 0.577*** 0.577*** 0.496***

(0.0397) (0.0465) (0.0575) (0.0594) (0.0631) (0.0631) (0.0562) (0.0340)

Adjusted R-squared 0.144 0.171 0.163 0.164 0.163 0.176 0.211 0.146


*** p<0.01, ** p<0.05, * p<0.1

Under OLS, growth of the

policy rate becomes an only influencing factor.

(1) (2) (3)

VARIABLES fsp1 fsp3 fsp5

1. Monetary Poicy

dpolrate 12.247*** 35.592*** -1.679

(4.284) (11.464) (1.477)

2. Business Cycle

ympi 7.741 -4.189 2.426

(7.169) (19.109) (2.353)

yexport 2.133 32.247 0.152

(7.408) (19.861) (2.506)

ykinflow -0.884* -3.320** 0.379*

(0.514) (1.365) (0.198)

ywhour 499.924*** -1233.362*** 141.304***

(54.819) (142.741) (14.523)

yneer 6.926 27.521 -8.034

(14.640) (38.928) (5.840)

3. Inflation

dinfla -1.843* -3.873 -2.560***

(0.998) (2.711) (0.288)

Constant 0.440 0.054 0.171


*** p<0.01, ** p<0.05, * p<0.1

Also, under VECM, an immediate effect is shown.

An increase in a policy

rate would also increase the forward spread.

Effects of the growth

rate of capital inflow,

working hours and

inflation rate on different maturities of

the forward spreads vary a lot.

1) The predictive power of the forward spread in

Thailand varies across different maturities. While the

Expectation Hypothesis(EH) explains most of the

change in future interest rates for yields with 1-year

time to maturity, the forecasts for yields with 3-year

and 5-year time to maturity are biased.

2) Only key factor influencing forward spread is growth

of policy rate. The impact is stronger in yields with

shorter time to maturities.

4. Conclusion

the forward spread in thailand

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