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An Arbitrage-Free Generalized Nelson-Siegel Term Structure Model

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Author Info
Jens H. E. Christensen () (Economic Research Department, Federal Reserve Bank of San Francisco)
Francis X. Diebold () (Department of Economics, University of Pennsylvania and NBER)
Glenn D. Rudebusch () (Economic Research Department, Federal Reserve Bank of San Francisco)

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Abstract

The Svensson generalization of the popular Nelson-Siegel term structure model is widely used by practitioners and central banks. Unfortunately, like the original Nelson-Siegel specification, this generalization, in its dynamic form, does not enforce arbitrage-free consistency over time. Indeed, we show that the factor loadings of the Svensson generalization cannot be obtained in a standard finance arbitrage-free affine term structure representation. Therefore, we introduce a closely related generalized Nelson-Siegel model on which the no-arbitrage condition can be imposed. We estimate this new arbitrage-free generalized Nelson-Siegel model and demonstrate its tractability and good in-sample fit.

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Publisher Info
Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 08-030.

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Length: 29 pages
Date of creation: 27 May 2008
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Handle: RePEc:pen:papers:08-030

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Related research
Keywords: Yield Curve Interest Rate Bond Market Svensson Model

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Find related papers by JEL classification:
C5 - Mathematical and Quantitative Methods - - Econometric Modeling
G1 - Financial Economics - - General Financial Markets

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Francis X. Diebold & Monika Piazzesi & Glenn D. Rudebusch, 2005. "Modeling bond yields in finance and macroeconomics," Working Paper Series 2005-04, Federal Reserve Bank of San Francisco. [Downloadable!]
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  2. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02. [Downloadable!] (restricted)
  3. Diebold, Francis X. & Li, Canlin, 2006. "Forecasting the term structure of government bond yields," Journal of Econometrics, Elsevier, vol. 130(2), pages 337-364, February. [Downloadable!] (restricted)
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  4. Don H. Kim & Athanasios Orphanides, 2005. "Term structure estimation with survey data on interest rate forecasts," Finance and Economics Discussion Series 2005-48, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  5. Glenn D. Rudebusch & Tao Wu, 2007. "Accounting for a Shift in Term Structure Behavior with No-Arbitrage and Macro-Finance Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 395-422, 03. [Downloadable!] (restricted)
  6. Diebold, Francis X. & Rudebusch, Glenn D. & Borag[caron]an Aruoba, S., 2006. "The macroeconomy and the yield curve: a dynamic latent factor approach," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 309-338. [Downloadable!] (restricted)
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  7. Bent Jesper Christensen & Tomas Björk, . "Interest Rate Dynamics and Consistent Forward Rate Curves," Management Working Papers 1999-4, School of Economics and Management, University of Aarhus. [Downloadable!]
  8. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October. [Downloadable!] (restricted)
  9. Qiang Dai & Kenneth J. Singleton, 2000. "Specification Analysis of Affine Term Structure Models," Journal of Finance, American Finance Association, vol. 55(5), pages 1943-1978, October. [Downloadable!] (restricted)
  10. Michiel De Pooter, 2007. "Examining the Nelson-Siegel Class of Term Structure Models," Tinbergen Institute Discussion Papers 07-043/4, Tinbergen Institute. [Downloadable!]
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