Principal component analysis of the yield curve

A Work Project, presented as part of the requirements for the Award of a Masters Degree in Finance from the NOVA – School of Business and Economics

This report deals with one of the remaining key problems in financial decision taking: the forecast of the term structure at different time horizons. Specifically: I will forecast the Euro Interest Rate Swap with a macro factor augmented autoregressive principal component model. I achieve forecasts that significantly outperform the Random Walk for medium to long term horizons when using a short rolling time window. Including macro factors leads to even better results.