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How arbitrage-free is the Nelson-Siegel Model?

  • Coroneo, Laura
  • Nyholm, Ken
  • Vidova-Koleva, Rositsa

We test whether the Nelson and Siegel (1987) yield curve model is arbitrage-free in a statistical sense. Theoretically, the Nelson-Siegel model does not ensure the absence of arbitrage opportunities, as shown by Bjork and Christensen (1999). Still, central banks and public wealth managers rely heavily on it. Using a non-parametric resampling technique and zero-coupon yield curve data from the US market, we find that the no-arbitrage parameters are not statistically different from those obtained from the NS model, at a 95 percent confidence level. We therefore conclude that the Nelson and Siegel yield curve model is compatible with arbitrage-freeness. To corroborate this result, we show that the Nelson-Siegel model performs as well as its no-arbitrage counterpart in an out-of-sample fore-casting experiment. JEL Classification: C14, C15, G12

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Paper provided by European Central Bank in its series Working Paper Series with number 0874.

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Date of creation: Feb 2008
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Handle: RePEc:ecb:ecbwps:20080874
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