A shape-based decomposition of the yield adjustment term in the arbitrage-free Nelson and Siegel (AFNS) model of the yield curve

James Steeley

Applied Financial Economics, 2014, vol. 24, issue 10, 661-669

Abstract: The appealing feature of the arbitrage-free Nelson--Siegel model of the yield curve is the ability to capture movements in the yield curve through readily interpretable shifts in its level, slope or curvature, all within a dynamic arbitrage-free framework. To ensure that the level, slope and curvature factors evolve so as not to admit arbitrage, the model introduces a yield-adjustment term. This paper shows how the yield-adjustment term can also be decomposed into the familiar level, slope and curvature elements plus some additional readily interpretable shape adjustments. This means that, even in an arbitrage-free setting, it continues to be possible to interpret movements in the yield curve in terms of level, slope and curvature influences.

Date: 2014
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DOI: 10.1080/09603107.2014.896980

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