Testing for omitted variables in a diffusion model with an application to term structure of interest rates

Payments Canada recently released its latest discussion paper, Testing for omitted variables in the diffusion matrix of a multivariate diffusion process with applications to term structure of interest rates. This paper provides tools that can be used to validate time-series regressions used in nowcasting.

This research has been developed to detect the potential misspecification of the volatility in a high-dimensional time-series model that could result in spurious forecasts when using such models. High dimensional time-series models are typically used in predicting trends in macroeconomic variables like GDP, inflation, and unemployment as well as the relationship between stock prices and volume.

PDF icon Testing for omitted variables in the diffusion matrix of a multivariate diffusion process with applications to term structure of interest rates