Modelling and forecasting international interest rate spreads: UK, Germany, Japan and the USA

The interest rate spread is of importance to policymakers and finance professionals in asset allocation and is a common measure of financial market stress. In this paper, we model and forecast the interest rate spreads for a number of countries using two well–known continuous time models and discrete time ARMA and ARFIMA models. We use monthly and weekly data which cover the recent global financial market crisis of 2007–2009 for Germany, Japan, UK and the USA. We find that the Merton's continuous–time model outperforms all other model specifications in terms of the mean of the forecast errors, MAPE and RMSE.