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Estimating the spot rate curve using the Nelson–Siegel model

Author

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  • Annaert, Jan
  • Claes, Anouk G.P.
  • De Ceuster, Marc J.K.
  • Zhang, Hairui

Abstract

The Nelson–Siegel model is widely used in practice for fitting the term structure of interest rates. Due to the ease in linearizing the model, a grid search or an OLS approach using a fixed shape parameter are popular estimation procedures. The estimated grid search parameters, however, have been reported (1) to behave erratically over time, and (2) to have relatively large variances. On the other hand, parameter estimates based on a fixed shape parameter, while avoiding multicollinearity, turn out to be too smooth. We show that the Nelson–Siegel model can become heavily collinear depending on the estimated/fixed shape parameter. A simple procedure based on ridge regression can remedy the reported problems significantly.

Suggested Citation

  • Annaert, Jan & Claes, Anouk G.P. & De Ceuster, Marc J.K. & Zhang, Hairui, 2013. "Estimating the spot rate curve using the Nelson–Siegel model," International Review of Economics & Finance, Elsevier, vol. 27(C), pages 482-496.
    • Handle: RePEc:eee:reveco:v:27:y:2013:i:c:p:482-496
    DOI: 10.1016/j.iref.2013.01.005
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    Cited by:

    1. Lily Y. Liu, 2017. "Estimating Loss Given Default from CDS under Weak Identification," Supervisory Research and Analysis Working Papers RPA 17-1, Federal Reserve Bank of Boston.
    2. Laurini, Márcio P. & Caldeira, João F., 2016. "A macro-finance term structure model with multivariate stochastic volatility," International Review of Economics & Finance, Elsevier, vol. 44(C), pages 68-90.
    3. Tomasz P. Kostyra, 2022. "Yield Curve Modelling with the Nelson-Siegel Method for Poland," Gospodarka Narodowa. The Polish Journal of Economics, Warsaw School of Economics, issue 2, pages 44-56.
    4. Bouwman, Kees & Buis, Boyd & Pieterse-Bloem, Mary & Tham, Wing Wah, 2015. "A practical approach to constructing price-based funding liquidity factors," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 90-97.
    5. González-Sánchez, Mariano, 2018. "Causality in the EMU sovereign bond markets," Finance Research Letters, Elsevier, vol. 26(C), pages 281-290.

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    More about this item

    Keywords

    Smoothed bootstrap; Ridge regression; Nelson–Siegel; Spot rates;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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