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A Smooth Shadow-Rate Dynamic Nelson-Siegel Model for Yields at the Zero Lower Bound

Author

Listed:
  • Daan Opschoor

    (Erasmus University Rotterdam)

  • Michel van der Wel

    (Erasmus University Rotterdam)

Abstract

We propose a smooth shadow-rate version of the dynamic Nelson-Siegel (DNS) model to analyze the term structure of interest rates during the recent zero lower bound (ZLB) period. By relaxing the no-arbitrage restriction, our shadow-rate model becomes highly tractable with a closed-form yield curve expression. The model easily permits the implementation of readily available DNS extensions such as time-varying loadings, integration of macroeconomic variables and time-varying volatility. Using U.S. Treasury data, we provide clear evidence of a smooth tran- sition of the yields entering and leaving the ZLB state. Moreover, we show that the smooth shadow-rate DNS model dominates the baseline DNS model in terms of fitting and forecasting the yield curve, while being competitive with a shadow-rate affine term structure model.

Suggested Citation

  • Daan Opschoor & Michel van der Wel, "undated". "A Smooth Shadow-Rate Dynamic Nelson-Siegel Model for Yields at the Zero Lower Bound," Tinbergen Institute Discussion Papers 22-011/III, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20220011
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    More about this item

    Keywords

    Yield curve; zero lower bound; shadow-rate model; Nelson-Siegel curve;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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