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A shape-based decomposition of the yield adjustment term in the arbitrage-free Nelson and Siegel (AFNS) model of the yield curve

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  • James M. Steeley

Abstract

The appealing feature of the arbitrage-free Nelson--Siegel model of the yield curve is the ability to capture movements in the yield curve through readily interpretable shifts in its level, slope or curvature, all within a dynamic arbitrage-free framework. To ensure that the level, slope and curvature factors evolve so as not to admit arbitrage, the model introduces a yield-adjustment term. This paper shows how the yield-adjustment term can also be decomposed into the familiar level, slope and curvature elements plus some additional readily interpretable shape adjustments. This means that, even in an arbitrage-free setting, it continues to be possible to interpret movements in the yield curve in terms of level, slope and curvature influences.

Suggested Citation

  • James M. Steeley, 2014. "A shape-based decomposition of the yield adjustment term in the arbitrage-free Nelson and Siegel (AFNS) model of the yield curve," Applied Financial Economics, Taylor & Francis Journals, vol. 24(10), pages 661-669, May.
    • Handle: RePEc:taf:apfiec:v:24:y:2014:i:10:p:661-669
    DOI: 10.1080/09603107.2014.896980
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    References listed on IDEAS

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    1. Leo Krippner, 2010. "A theoretical foundation for the Nelson and Siegel class of yield curve models, and an empirical application to U.S. yield curve dynamics," Reserve Bank of New Zealand Discussion Paper Series DP2010/11, Reserve Bank of New Zealand.
    2. Nicola Anderson & John Sleath, 2001. "New estimates of the UK real and nominal yield curves," Bank of England working papers 126, Bank of England.
    3. Mark Deacon & Andrew Derry, 1994. "Estimating the Term Structure of Interest Rates," Bank of England working papers 24, Bank of England.
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