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

  • Martin Gonzalez-Rozada


  • Martin sola


  • Constantino Hevia


  • Fabio Spagnolo


In this paper we estimate the yield curve of U.S. government bonds using a Markov switching latent variable model. We show how measures such as the level, slope, and curvature of the yield curve are a¤ected by business cycle conditions. We present a switching latent model which not only seem to capture this features in sample but also performs well out of sample.

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Paper provided by Universidad Torcuato Di Tella in its series Department of Economics Working Papers with number 2012-07.

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Length: 47 pages
Date of creation: Jul 2012
Date of revision:
Handle: RePEc:udt:wpecon:2012-07
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  1. Darrell Duffie & Rui Kan, 1996. "A Yield-Factor Model Of Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(4), pages 379-406.
  2. Bianchi, Francesco & Mumtaz, Haroon & Surico, Paolo, 2009. "The great moderation of the term structure of UK interest rates," Journal of Monetary Economics, Elsevier, vol. 56(6), pages 856-871, September.
  3. 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.
  4. Roberto Burguet & Martin K. Perry, 2009. "Preferred suppliers in auction markets," RAND Journal of Economics, RAND Corporation, vol. 40(2), pages 283-295.
  5. Donald W.K. Andrews, 1988. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Cowles Foundation Discussion Papers 877R, Cowles Foundation for Research in Economics, Yale University, revised Jul 1989.
  6. Diebold, Francis X. & Rudebusch, Glenn D. & Borag[caron]an Aruoba, S., 2006. "The macroeconomy and the yield curve: a dynamic latent factor approach," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 309-338.
  7. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
  8. Zacharias Psaradakis & Nicola Spagnolo, 2002. "On the Determination of the Number of Regimes in Markov-Switching Autoregressive Models," Computing in Economics and Finance 2002 83, Society for Computational Economics.
  9. Naegelen, Florence & Mougeot, Michel, 1998. "Discriminatory public procurement policy and cost reduction incentives," Journal of Public Economics, Elsevier, vol. 67(3), pages 349-367, March.
  10. Branco, Fernando, 1994. "Favoring domestic firms in procurement contracts," Journal of International Economics, Elsevier, vol. 37(1-2), pages 65-80, August.
  11. Harvey, David & Leybourne, Stephen & Newbold, Paul, 1997. "Testing the equality of prediction mean squared errors," International Journal of Forecasting, Elsevier, vol. 13(2), pages 281-291, June.
  12. Leandro Arozamena & Federico Weinschelbaum, 2010. "On Favoritism in Auctions with Entry," Working Papers 103, Universidad de San Andres, Departamento de Economia, revised May 2010.
  13. Leandro Arozamena & Federico Weinschelbaum, 2006. "A note on the suboptimality of right-of-first-refusal clauses," Economics Bulletin, AccessEcon, vol. 4(24), pages 1-5.
  14. Bikbov, Ruslan & Chernov, Mikhail, 2013. "Monetary policy regimes and the term structure of interest rates," Journal of Econometrics, Elsevier, vol. 174(1), pages 27-43.
  15. Yu, Wei-Choun & Zivot, Eric, 2011. "Forecasting the term structures of Treasury and corporate yields using dynamic Nelson-Siegel models," International Journal of Forecasting, Elsevier, vol. 27(2), pages 579-591.
  16. McAfee, R. Preston & McMillan, John, 1989. "Government procurement and international trade," Journal of International Economics, Elsevier, vol. 26(3-4), pages 291-308, May.
  17. Ju Xiang & Xiaoneng Zhu, 2013. "A Regime-Switching Nelson--Siegel Term Structure Model and Interest Rate Forecasts," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 11(3), pages 522-555, June.
  18. Ravi Bansal & Hao Zhou, 2001. "Term structure of interest rates with regime shifts," Finance and Economics Discussion Series 2001-46, Board of Governors of the Federal Reserve System (U.S.).
  19. Knez, Peter J & Litterman, Robert & Scheinkman, Jose Alexandre, 1994. " Explorations into Factors Explaining Money Market Returns," Journal of Finance, American Finance Association, vol. 49(5), pages 1861-82, December.
  20. Kim, C-J., 1991. "Dynamic Linear Models with Markov-Switching," Papers 91-8, York (Canada) - Department of Economics.
  21. Francis X. Diebold & Robert S. Mariano, 1994. "Comparing Predictive Accuracy," NBER Technical Working Papers 0169, National Bureau of Economic Research, Inc.
  22. Koopman, Siem Jan & Mallee, Max I. P. & Van der Wel, Michel, 2010. "Analyzing the Term Structure of Interest Rates Using the Dynamic Nelson–Siegel Model With Time-Varying Parameters," Journal of Business & Economic Statistics, American Statistical Association, vol. 28(3), pages 329-343.
  23. Vagstad, Steinar, 1995. "Promoting fair competition in public procurement," Journal of Public Economics, Elsevier, vol. 58(2), pages 283-307, October.
  24. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October.
  25. Driffill John & Kenc Turalay & Sola Martin & Spagnolo Fabio, 2009. "The Effects of Different Parameterizations of Markov-Switching in a CIR Model of Bond Pricing," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 13(1), pages 1-24, March.
  26. Coroneo, Laura & Nyholm, Ken & Vidova-Koleva, Rositsa, 2011. "How arbitrage-free is the Nelson-Siegel model?," Journal of Empirical Finance, Elsevier, vol. 18(3), pages 393-407, June.
  27. Laffont, Jean-Jacques & Tirole, Jean, 1991. "Auction design and favoritism," International Journal of Industrial Organization, Elsevier, vol. 9(1), pages 9-42, March.
  28. Laura Coroneo & Domenico Giannone & Michèle Modugno, 2013. "Unspanned Macroeconomic Factors in the Yields Curve," Working Papers ECARES ECARES 2013-07, ULB -- Universite Libre de Bruxelles.
  29. Lee, Joon-Suk, 2008. "Favoritism in asymmetric procurement auctions," International Journal of Industrial Organization, Elsevier, vol. 26(6), pages 1407-1424, November.
  30. repec:ebl:ecbull:v:4:y:2006:i:24:p:1-5 is not listed on IDEAS
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