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Investigating the Relationships between the Yield Curve, Output and Inflation using an Arbitrage-Free Version of the Nelson and Siegel Class of Yield Curve Models

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  • Leo Krippner

    (AMP Capital Investors)

Abstract

This article provides a theoretical economic foundation for the popular Nelson and Siegel (1987) class of yield curve models (which has been absent up to now). This foundation also offers a new framework for investigating and interpreting the relationships between the yield curve, output and inflation that have already been well-established empirically in the literature. Specifically, the level of the yield curve as measured by the VAO model is predicted to have a cointegrating relationship with inflation, and the shape of the yield curve as measured by the VAO model is predicted to correspond to the profile (that is, timing and magnitude) of future changes in the output gap (that is, output growth less the growth in potential output). These relationships are confirmed in the empirical analysis on 50 years of United States data.

Suggested Citation

  • Leo Krippner, 2005. "Investigating the Relationships between the Yield Curve, Output and Inflation using an Arbitrage-Free Version of the Nelson and Siegel Class of Yield Curve Models," Working Papers in Economics 05/02, University of Waikato.
    • Handle: RePEc:wai:econwp:05/02
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    More about this item

    Keywords

    yield curve; term structure of interest rates; Nelson and Siegel model; inflation; output;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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