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

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  • Leo Krippner

    (AMP)

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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Bibliographic Info

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
Date of revision:
Handle: RePEc:uts:rpaper:226

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Keywords: yield curve; term structure of interest rates; macro-finance; Nelson and Siegel model; Heath-Jarrow-Morton framework;

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References

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  1. Caroline Jardet, 2002. "Why did the Term Structure of Interest Rates Lose its Predictive Power ?," Working Papers 2002-05, Centre de Recherche en Economie et Statistique.
  2. James D. Hamilton & Dong Heon Kim, 2000. "A Re-examination of the Predictability of Economic Activity Using the Yield Spread," NBER Working Papers 7954, National Bureau of Economic Research, Inc.
  3. Arturo Estrella & Anthony P. Rodrigues & Sebastian Schich, 2003. "How Stable is the Predictive Power of the Yield Curve? Evidence from Germany and the United States," The Review of Economics and Statistics, MIT Press, vol. 85(3), pages 629-644, August.
  4. Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January.
  5. Leo Krippner, 2006. "A Theoretically Consistent Version of the Nelson and Siegel Class of Yield Curve Models," Applied Mathematical Finance, Taylor & Francis Journals, vol. 13(1), pages 39-59.
  6. Arturo Estrella, 2005. "Why Does the Yield Curve Predict Output and Inflation?," Economic Journal, Royal Economic Society, vol. 115(505), pages 722-744, 07.
  7. Christensen, Jens H.E. & Diebold, Francis X. & Rudebusch, Glenn D., 2011. "The affine arbitrage-free class of Nelson-Siegel term structure models," Journal of Econometrics, Elsevier, vol. 164(1), pages 4-20, September.
  8. Francis X. Diebold & Canlin Li, 2002. "Forecasting the Term Structure of Government Bond Yields," Center for Financial Institutions Working Papers 02-34, Wharton School Center for Financial Institutions, University of Pennsylvania.
  9. Dahlquist, Magnus & Svensson, Lars E O, 1996. " Estimating the Term Structure of Interest Rates for Monetary Policy Analysis," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(2), pages 163-83, June.
  10. Michael D. Bordo & Joseph G Haubrich, 2004. "The Yield Curve, Recessions and the Credibility of the Monetary Regime: Long Run Evidence 1875-1997," NBER Working Papers 10431, National Bureau of Economic Research, Inc.
  11. Ioannides, Michalis, 2003. "A comparison of yield curve estimation techniques using UK data," Journal of Banking & Finance, Elsevier, vol. 27(1), pages 1-26, January.
  12. Refet S. Gürkaynak & Brian Sack & Jonathan H. Wright, 2006. "The U.S. Treasury yield curve: 1961 to the present," Finance and Economics Discussion Series 2006-28, Board of Governors of the Federal Reserve System (U.S.).
  13. Diebold, Francis X. & Piazzesi, Monica & Rudebusch, Glenn D., 2005. "Modeling bond yields in finance and macroeconomics," CFS Working Paper Series 2005/03, Center for Financial Studies (CFS).
  14. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
  15. Mohamed Safouane Ben Aissa & Jamel Jouini, 2003. "Structural breaks in the US inflation process," Applied Economics Letters, Taylor & Francis Journals, vol. 10(10), pages 633-636.
  16. Nakaota, Hiroshi, 2005. "The term structure of interest rates in Japan: the predictability of economic activity," Japan and the World Economy, Elsevier, vol. 17(3), pages 311-326, August.
  17. Francis X. Diebold & Glenn D. Rudebusch & S. Boragan Aruoba, 2004. "The Macroeconomy and the Yield Curve: A Dynamic Latent Factor Approach," NBER Working Papers 10616, National Bureau of Economic Research, Inc.
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  19. McCulloch, J Huston, 1971. "Measuring the Term Structure of Interest Rates," The Journal of Business, University of Chicago Press, vol. 44(1), pages 19-31, January.
  20. Newey, Whitney K & West, Kenneth D, 1994. "Automatic Lag Selection in Covariance Matrix Estimation," Review of Economic Studies, Wiley Blackwell, vol. 61(4), pages 631-53, October.
  21. Pham, Toan M., 1998. "Estimation of the term structure of interest rates: an international perspective," Journal of Multinational Financial Management, Elsevier, vol. 8(2-3), pages 265-283, September.
  22. Paya, Ivan & Matthews, Kent & Peel, David, 2005. "The term spread and real economic activity in the US inter-war period," Journal of Macroeconomics, Elsevier, vol. 27(2), pages 331-343, June.
  23. James Steeley, 2004. "Estimating time-varying risk premia in UK long-term government bonds," Applied Financial Economics, Taylor & Francis Journals, vol. 14(5), pages 367-373.
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Cited by:
  1. Leo Krippner, 2010. "Connecting the dots: a yield curve perspective on New Zealand’s interest rates," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 73, September.
  2. Leo Krippner, 2014. "Measuring the stance of monetary policy in conventional and unconventional environments," CAMA Working Papers 2014-06, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.

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