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Investigating the Relationships between the Yield Curve, Output and Inflation using an Arbitrage-Free Version of the Nelson and Siegel Class of Yield Curve Models

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Author Info
Leo Krippner () (AMP Capital Investors)

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Abstract

This article provides a theoretical economic foundation for the popular Nelson and Siegel (1987) class of yield curve models (which has been absent up to now). This foundation also offers a new framework for investigating and interpreting the relationships between the yield curve, output and inflation that have already been well-established empirically in the literature. Specifically, the level of the yield curve as measured by the VAO model is predicted to have a cointegrating relationship with inflation, and the shape of the yield curve as measured by the VAO model is predicted to correspond to the profile (that is, timing and magnitude) of future changes in the output gap (that is, output growth less the growth in potential output). These relationships are confirmed in the empirical analysis on 50 years of United States data.

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Publisher Info
Paper provided by University of Waikato, Department of Economics in its series Working Papers in Economics with number 05/02.

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Length: 34 pages
Date of creation: 01 Feb 2005
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Handle: RePEc:wai:econwp:05/02

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Related research
Keywords: yield curve; term structure of interest rates; Nelson and Siegel model; inflation; output;

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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

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