How Arbitrage-free is the Nelson-Siegel Model?

Laura Coroneo (), Ken Nyholm () and Vidova-Koleva, Rositsa ()
Additional contact information
Laura Coroneo: ECARES, Universite Libre de Bruxelles, avenue Roosevelt 50 CP114, B-1050 Bruxelles, Belgium., http://www.ecare.ulb.ac.be/ecare/
Ken Nyholm: European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany., http://www.ecb.europa.eu/home/html/index.en.html
Vidova-Koleva, Rositsa: IDEA, Departament d’Economia i d’Història Econòmica, Universitat Autònoma de Barcelona, 08193, Bellaterra (Barcelona), Spain., http://idea.uab.es/activities.html

No 874, Working Paper Series from European Central Bank

Abstract: 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 forecasting experiment. JEL Classification: C14, C15, G12.

Keywords: Keywords Nelson-Siegel model; No-arbitrage restrictions; affine term structure models; non-parametric test. (search for similar items in EconPapers)
Date: Written 2008-02

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