The Predictive Power of Nelson-Siegel Factor Loadings for the Real Economy
51 Pages Posted: 4 Aug 2016 Last revised: 22 Sep 2017
Date Written: September 21, 2017
We allow the loading parameter λ in the Nelson-Siegel model to vary over time in a simplistic way that was originally experimented by Nelson and Siegel (1987). We find that the time-varying λ factor, which determines the relative factor loadings, increases dramatically and becomes volatile ahead of recessions, and declines afterward in both its level and volatility. Information in the time-varying λ factor has strong predictive power for real economic activity at horizons beyond 12 months. We show that information in the time-varying λ factor is independent of other conventional yield curve predictors, such as the yield spread, and is informative to the future market uncertainty.
Keywords: Yield Curve, Term Structure of Interest Rate, Uncertainty, Nelson-Siegel Model, Economic Activity Forecasting
JEL Classification: G17, E43, E44, E47, C53
Suggested Citation: Suggested Citation