A theoretical foundation for the Nelson and Siegel class of yield curve models

Business Australia North America

Yield curve models within the popular Nelson and Siegel (hereafter NS) class are shown to arise from a formal low-order Taylor approximation to the generic Gaussian affine term structure model.

That theoretical foundation provides an assurance that NS models correspond to a well-accepted framework for yield curve modeling.It further suggests that any yield curve from the GATSM class should be parsimoniously representable by an two-factor arbitrage-free NS model, which should prove useful for macro…nance applications. Such a model is derived and applied to provide evidence for changes in United States yield curve dynamics pre- and post-1988.

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