The Affine Arbitrage-Free Class of Nelson-Siegel Term Structure Models

38 Pages Posted: 1 Oct 2007

See all articles by Francis X. Diebold

Francis X. Diebold

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Jens Henrik Eggert Christensen

FRB of San Francisco - Financial Research

Glenn D. Rudebusch

Federal Reserve Bank of San Francisco

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Abstract

We derive the class of arbitrage-free affine dynamic term structure models that approximate the widely-used Nelson-Siegel yield-curve specification. Our theoretical analysis relates this new class of models to the canonical representation of the three-factor arbitrage-free affine model. Our empirical analysis shows that imposing the Nelson-Siegel structure on this canonical representation greatly improves its empirical tractability; furthermore, we find that improvements in predictive performance are achieved from the imposition of absence of arbitrage.

Keywords: arbitrage, Nelson-Siegel, term structure, factor models, forecast accuracy

JEL Classification: C5, G1, E4

Suggested Citation

Diebold, Francis X. and Christensen, Jens Henrik Eggert and Rudebusch, Glenn D., The Affine Arbitrage-Free Class of Nelson-Siegel Term Structure Models. PIER Working Paper No. 07-029, Available at SSRN: https://ssrn.com/abstract=1018466

Francis X. Diebold (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
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HOME PAGE: http://www.ssc.upenn.edu/~fdiebold/

National Bureau of Economic Research (NBER)

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Jens Henrik Eggert Christensen

FRB of San Francisco - Financial Research ( email )

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415-974-3115 (Phone)

Glenn D. Rudebusch

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

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