Estimating the Yield Curve Using the Nelson-Siegel Model: A Ridge Regression Approach
University of Antwerp Department of Accounting & Finance; Antwerp Management School
Anouk G. P. Claes
Facultés Universitaires Saint-Louis, Faculté ESPO; University of Antwerp, Faculty of Applied Economics - City Campus
Marc J. K. de Ceuster
University of Antwerp - Faculty of Applied Economics - City Campus
Universiteit Antwerpen; Antwerp Management School; Facultés Universitaires Saint Louis à Bruxelles
May 8, 2012
International Review of Economics & Finance, Forthcoming
The Nelson-Siegel model is widely used in practice for fitting the term structure of interest rates. Due to the ease in linearizing the model, a grid search or an OLS approach using a fixed shape parameter are popular estimation procedures. The estimated parameters, however, have been reported (1) to behave erratically over time, and (2) to have relatively large variances. We show that the Nelson-Siegel model can become heavily collinear depending on the estimated/fixed shape parameter. A simple procedure based on ridge regression can remedy the reported problems significantly.
Number of Pages in PDF File: 44
Keywords: Smoothed Bootstrap, Ridge Regression, Nelson-Siegel, Spot Rates
JEL Classification: E43, C51
Date posted: May 8, 2012 ; Last revised: February 16, 2015
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