Abstract
The interest rate spread is of importance to policy-makers 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.
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