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Estimating and Forecasting the Yield Curve Using A Markov Switching Dynamic Nelson and Siegel Model

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  • Constantino Hevia
  • Martin Gonzalez‐Rozada
  • Martin Sola
  • Fabio Spagnolo

Abstract

We estimate versions of the Nelson-Siegel model of the yield curve of U.S. government bonds using a Markov switching latent variable model that allows for discrete changes in the stochastic process followed by the interest rates. Our modelling approach is motivated by evidence suggesting the existence of breaks in the behaviour of the U.S. yield curve that depend, for example, on whether the economy is in a recession or a boom, or on the stance of monetary policy. Our model is parsimonious, relatively easy to estimate, and flexible enough to match the changing shapes of the yield curve over time. We also derive the discrete time non-arbitrage restrictions for the Markov switching model. We compare the forecasting performance of these models with that of the standard dynamic Nelson and Siegel model and an extension that allows the decay rate parameter to be time-varying. We show that some parameterizations of our model with regime shifts outperform the single regime Nelson and Siegel model and other standard empirical models of the yield curve.
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Suggested Citation

  • Constantino Hevia & Martin Gonzalez‐Rozada & Martin Sola & Fabio Spagnolo, 2015. "Estimating and Forecasting the Yield Curve Using A Markov Switching Dynamic Nelson and Siegel Model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 30(6), pages 987-1009, September.
  • Handle: RePEc:wly:japmet:v:30:y:2015:i:6:p:987-1009
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    References listed on IDEAS

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    Cited by:

    1. Fausto Vieira & Fernando Chague, Marcelo Fernandes, 2016. "A dynamic Nelson-Siegel model with forward-looking indicators for the yield curve in the US," Working Papers, Department of Economics 2016_31, University of São Paulo (FEA-USP).
    2. repec:eee:ecmode:v:67:y:2017:i:c:p:73-87 is not listed on IDEAS

    More about this item

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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