A Macroeconomic Foundation for the Nelson and Siegel Class of Yield Curve Models

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A Macroeconomic Foundation for the Nelson and Siegel Class of Yield Curve Models

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Leo Krippner (AMP)

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Leo Krippner

Abstract

Yield curve models of the Nelson and Siegel (1987) class have proven themselves popular empirical tools in finance and economics, but they lack a formal theoretical justification. Hence, this article uses a multifactor version of the Cox, Ingersoll and Ross (1985a) continuous-time general-equilibrium economy to derive a macroeconomic foundation for a theoretically-consistent version of the Nelson and Siegel class of yield curve models. It is established that the level and shape of the yield curve as represented by NS models may be explained succinctly in terms of expectations of inflation and real output growth within an underlying economic model. This theoretically-rigorous yet parsimonious and intuitive framework is applicable as a macro-finance tool, and the application in this article provides a ready interpretation of a series of empirical results from the macro-finance literature that relate the level and slope of the yield curve to output growth and inflation.

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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 226.

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Length: 27
Date of creation: 01 Jun 2008
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Handle: RePEc:uts:rpaper:226

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Find related papers by JEL classification:
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

This paper has been announced in the following NEP Reports:

NEP-ALL-2008-07-20 (All new papers)
NEP-MAC-2008-07-20 (Macroeconomics)
NEP-MON-2008-07-20 (Monetary Economics)

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