An Arbitrage-Free Generalized Nelson-Siegel Term Structure Model
The Svensson generalization of the popular Nelson-Siegel term structure model is widely used by practitioners and central banks. Unfortunately, like the original Nelson-Siegel specification, this generalization, in its dynamic form, does not enforce arbitrage-free consistency over time. Indeed, we show that the factor loadings of the Svensson generalization cannot be obtained in a standard finance arbitrage-free affine term structure representation. Therefore, we introduce a closely related generalized Nelson-Siegel model on which the no-arbitrage condition can be imposed. We estimate this new arbitrage-free generalized Nelson-Siegel model and demonstrate its tractability and good in-sample fit.
We thank Richard Smith for organizing the Special Session on Financial Econometrics at the 2008 meeting of the Royal Economic Society, at which we first presented this paper. We also thank our discussant, Alessio Sancetta. The views expressed are those of the authors and do not necessarily reflect the views of others at the Federal Reserve Bank of San Francisco, nor the views of the National Bureau of Economic Research.
Jens H. E. Christensen & Francis X. Diebold & Glenn D. Rudebusch, 2009. "An arbitrage-free generalized Nelson--Siegel term structure model," Econometrics Journal, Royal Economic Society, vol. 12(3), pages C33-C64, November. citation courtesy of