An Intertemporally-Consistent and Arbitrage-Free Version of the Nelson and Siegel Class of Yield Curve Models

Leo Krippner ()

Working Papers in Economics from University of Waikato, Department of Economics

Abstract: This article derives a generic, intertemporally-consistent, and arbitrage-free version of the popular class of yield curve models originally introduced by Nelson and Siegel (1987). The derived model has a theoretical foundation (conferred via the Heath, Jarrow and Morton (1992) framework) that allows it to be used in applications that involve an implicit or explicit time-series context. As an example of the potentialapplication of the model, the intertemporal consistency is exploited to derive a theoretical time-series process that may be used to forecast the yield curve. The empirical application of the forecasting framework to United States data results in out-of-sample forecasts that outperform the random walk over a sample period of almost 50 years, for forecast horizons ranging from six months to three years.

Keywords: yield curve; term structure of interest rates; Nelson and Siegel model; Heath-Jarrow-Morton framework (search for similar items in EconPapers)
JEL-codes: E43 C22 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin and nep-mac
Date: 2005-01-31
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