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The Affine Arbitrage-Free Class of Nelson-Siegel Term Structure Models

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  • Jens H. E. Christensen

    ()
    (Financial Research, Federal Reserve Bank of San Francisco)

  • Francis X. Diebold

    ()
    (Department of Economics, University of Pennsylvania)

  • Glenn D. Rudebusch

    ()
    (Economic Research Department, Federal Reserve Bank of San Francisco)

Abstract

We derive the class of arbitrage-free affine dynamic term structure models that approximate the widely-used Nelson-Siegel yield-curve specification. Our theoretical analysis relates this new class of models to the canonical representation of the three-factor arbitrage-free affine model. Our empirical analysis shows that imposing the Nelson-Siegel structure on this canonical representation greatly improves its empirical tractability; furthermore, we find that improvements in predictive performance are achieved from the imposition of absence of arbitrage.

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Bibliographic Info

Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 07-029.

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Length: 38 pages
Date of creation: 11 Sep 2007
Date of revision:
Handle: RePEc:pen:papers:07-029

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Keywords: arbitrage; Nelson-Siegel; term structure; factor models; forecast accuracy;

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