Estimating the Yield Curve Using the Nelson-Siegel Model: A Ridge Regression Approach

44 Pages Posted: 8 May 2012 Last revised: 16 Feb 2015

Jan Annaert

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

Hairui Zhang

Universiteit Antwerpen; Antwerp Management School; Facultés Universitaires Saint Louis à Bruxelles

Date Written: May 8, 2012

Abstract

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.

Keywords: Smoothed Bootstrap, Ridge Regression, Nelson-Siegel, Spot Rates

JEL Classification: E43, C51

Suggested Citation

Annaert, Jan and Claes, Anouk G. P. and de Ceuster, Marc J. K. and Zhang, Hairui, Estimating the Yield Curve Using the Nelson-Siegel Model: A Ridge Regression Approach (May 8, 2012). International Review of Economics & Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2054689 or http://dx.doi.org/10.2139/ssrn.2054689

Jan Annaert

University of Antwerp Department of Accounting & Finance ( email )

Faculty of Applied Economics
Prinsstraat 13
Antwerp, B-2000
Belgium

HOME PAGE: http://https://www.uantwerp.be/en/staff/jan-annaert/

Antwerp Management School ( email )

Het Brantijser
Sint-Jacobsmarkt 9-13
Antwerp, 2000
Belgium

Anouk G. P. Claes

Facultés Universitaires Saint-Louis, Faculté ESPO ( email )

Boulevard du Jardin Botanique 43
Brussels, 1000
Belgium
+32 2 787 93 15 (Phone)

University of Antwerp, Faculty of Applied Economics - City Campus ( email )

Prinsstraat 13
Antwerp, 2000
Belgium
+32 220 40 64 (Fax)

HOME PAGE: http://www.ua.ac.be/anouk.claes

Marc J. K. De Ceuster (Contact Author)

University of Antwerp - Faculty of Applied Economics - City Campus ( email )

Office B-337
Prinsstraat 13
Antwerp, Antwerp 2000
Belgium
+ 32 3 220 41 24 (Phone)
+ 32 3 220 40 64 (Fax)

HOME PAGE: http://www.ua.ac.be/marc.deceuster

Hairui Zhang

Universiteit Antwerpen ( email )

Prinsstraat 13
Antwerp, 2000
Belgium

HOME PAGE: http://https://www.uantwerpen.be/en/staff/hairui-zhang/

Antwerp Management School ( email )

Het Brantijser
Sint-Jacobsmarkt 9-13
Antwerp, 2000
Belgium

HOME PAGE: http://www.antwerpmanagementschool.be/en/faculty-research/faculty/zhang-hairui-e

Facultés Universitaires Saint Louis à Bruxelles ( email )

Boulevard du Jardin Botanique 43
Bruxelles, 1000
Belgium

HOME PAGE: http://www.usaintlouis.be/sl/4026048.html

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