Examining the Nelson-Siegel Class of Term Structure Models: In-Sample Fit versus Out-of-Sample Forecasting Performance
56 Pages Posted: 12 Jun 2007 Last revised: 20 Oct 2007
Date Written: September 23, 2007
In this paper I examine various extensions of the Nelson and Siegel (1987) model with the purpose of fitting and forecasting the term structure of interest rates. As expected, I find that using more flexible models leads to a better in-sample fit of the term structure. However, I show that the out-of-sample predictability improves as well. A four-factor model, which adds a second slope factor to the three-factor Nelson-Siegel model, forecasts particularly well. Especially with a one-step state-space estimation approach the four-factor model produces accurate forecasts and outperforms competitor models across maturities and forecast horizons. Subsample analysis shows that this outperformance is also consistent over time.
Keywords: Term structure of interest rates, Nelson-Siegel, Svensson, Forecasting, State-space model
JEL Classification: E4, C5, C32
Suggested Citation: Suggested Citation