How Arbitrage-Free is the Nelson-Siegel Model?

60 Pages Posted: 27 Feb 2008

See all articles by Laura Coroneo

Laura Coroneo

University of York - Department of Economics and Related Studies

Ken Nyholm

European Central Bank (ECB)

Rositsa Vidova-Koleva

affiliation not provided to SSRN

Date Written: February 2008

Abstract

We test whether the Nelson and Siegel (1987) yield curve model is arbitrage-free in a statistical sense. Theoretically, the Nelson-Siegel model does not ensure the absence of arbitrage opportunities, as shown by Bjork and Christensen (1999). Still, central banks and public wealth managers rely heavily on it. Using a non-parametric resampling technique and zero-coupon yield curve data from the US market, we find that the no-arbitrage parameters are not statistically different from those obtained from the NS model, at a 95 percent confidence level. We therefore conclude that the Nelson and Siegel yield curve model is compatible with arbitrage-freeness. To corroborate this result, we show that the Nelson-Siegel model performs as well as its no-arbitrage counterpart in an out-of-sample forecasting experiment.

Keywords: Nelson-Siegel model, No-arbitrage restrictions, affine term structure models, non-parametric test

JEL Classification: C14, C15, G12

Suggested Citation

Coroneo, Laura and Nyholm, Ken and Vidova-Koleva, Rositsa, How Arbitrage-Free is the Nelson-Siegel Model? (February 2008). ECB Working Paper No. 874, Available at SSRN: https://ssrn.com/abstract=1091123

Laura Coroneo (Contact Author)

University of York - Department of Economics and Related Studies ( email )

Heslington
York, YO1 5DD
United Kingdom

Ken Nyholm

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Rositsa Vidova-Koleva

affiliation not provided to SSRN ( email )

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