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A Macroeconomic Foundation for the Nelson and Siegel Class of Yield Curve Models

  • Leo Krippner

    (AMP)

Yield curve models of the Nelson and Siegel (1987) class have proven themselves popular empirical tools in finance and economics, but they lack a formal theoretical justification. Hence, this article uses a multifactor version of the Cox, Ingersoll and Ross (1985a) continuous-time general-equilibrium economy to derive a macroeconomic foundation for a theoretically-consistent version of the Nelson and Siegel class of yield curve models. It is established that the level and shape of the yield curve as represented by NS models may be explained succinctly in terms of expectations of inflation and real output growth within an underlying economic model. This theoretically-rigorous yet parsimonious and intuitive framework is applicable as a macro-finance tool, and the application in this article provides a ready interpretation of a series of empirical results from the macro-finance literature that relate the level and slope of the yield curve to output growth and inflation.

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File URL: http://www.business.uts.edu.au/qfrc/research/research_papers/rp226.pdf
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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 226.

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Length: 27
Date of creation: 01 Jun 2008
Date of revision:
Handle: RePEc:uts:rpaper:226
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  2. Michael D. Bordo & Joseph G. Haubrich, 2004. "The yield curve, recessions, and the credibility of the monetary regime: long-run evidence, 1875-1997," Working Paper 0402, Federal Reserve Bank of Cleveland.
  3. Jens H.E. Christensen & Francis X. Diebold & Glenn D. Rudebusch, 2007. "The affine arbitrage-free class of Nelson-Siegel term structure models," Working Paper Series 2007-20, Federal Reserve Bank of San Francisco.
  4. Francis X. Diebold & Monika Piazzesi & Glenn Rudebusch, 2005. "Modeling Bond Yields in Finance and Macroeconomics," NBER Working Papers 11089, National Bureau of Economic Research, Inc.
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  7. Jardet, Caroline, 2004. "Why did the term structure of interest rates lose its predictive power?," Economic Modelling, Elsevier, vol. 21(3), pages 509-524, May.
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  9. Pham, Toan M., 1998. "Estimation of the term structure of interest rates: an international perspective," Journal of Multinational Financial Management, Elsevier, vol. 8(2-3), pages 265-283, September.
  10. Gurkaynak, Refet S. & Sack, Brian & Wright, Jonathan H., 2007. "The U.S. Treasury yield curve: 1961 to the present," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2291-2304, November.
  11. Kenneth D. West & Whitney K. Newey, 1995. "Automatic Lag Selection in Covariance Matrix Estimation," NBER Technical Working Papers 0144, National Bureau of Economic Research, Inc.
  12. Arturo Estrella, 2005. "Why Does the Yield Curve Predict Output and Inflation?," Economic Journal, Royal Economic Society, vol. 115(505), pages 722-744, 07.
  13. Arturo Estrella & Anthony P. Rodrigues & Sebastian Schich, 2003. "How Stable is the Predictive Power of the Yield Curve? Evidence from Germany and the United States," The Review of Economics and Statistics, MIT Press, vol. 85(3), pages 629-644, August.
  14. Leo Krippner, 2006. "A Theoretically Consistent Version of the Nelson and Siegel Class of Yield Curve Models," Applied Mathematical Finance, Taylor & Francis Journals, vol. 13(1), pages 39-59.
  15. Dahlquist, Magnus & Svensson, Lars E O, 1996. " Estimating the Term Structure of Interest Rates for Monetary Policy Analysis," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(2), pages 163-83, June.
  16. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
  17. Ioannides, Michalis, 2003. "A comparison of yield curve estimation techniques using UK data," Journal of Banking & Finance, Elsevier, vol. 27(1), pages 1-26, January.
  18. McCulloch, J Huston, 1971. "Measuring the Term Structure of Interest Rates," The Journal of Business, University of Chicago Press, vol. 44(1), pages 19-31, January.
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