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

Leo Krippner

No 226, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: 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.

Keywords: yield curve; term structure of interest rates; macro-finance; Nelson and Siegel model; Heath-Jarrow-Morton framework (search for similar items in EconPapers)
JEL-codes: E43 E31 E32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac and nep-mon
Date: 2008-06-01
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