Foreign trade and China’s yield curve during the COVID-19 pandemic: An analysis based on an extended arbitrage-free Nelson–Siegel model

We propose a general extension of the arbitrage-free Nelson–Siegel (AFNS) model by incorporating exogenous factors into the unspanned AFNS model. Regarding the number of people newly diagnosed with COVID-19 as an exogenous shock and net foreign purchases of treasury bonds of different maturities as unspanned factors, we study the impacts of the COVID-19 pandemic and the trading behavior of foreign investors on the yield curve in China. Our empirical results show that the COVID-19 pandemic significantly increases net foreign purchases of short-to-medium-term treasury bonds while significantly reducing the long-term treasury yield. Net foreign purchases of treasury bonds of different maturities cause large shifts with different shapes in the yield curve and have different effects on the excess returns of bonds of different maturities. This paper provides an important reference for risk management, investment decision-making and risk assessment of China’s financial opening policy for its treasury bond market.