Abstract
Abstract Following (Almeida, Ardison, Kubudi, Simonsen, & Vicente, 2018) we implement a segmented three factor Nelson-Siegel model for the yield curve using daily observable bond prices and short term interbank rates for Colombia. The flexible estimation for each segment (short, medium, and long) provides an improvement over the classical Nelson-Siegel approach in particular in terms of in-sample and out-of-sample forecasting performance. A segmented term structure model based on observable bond prices provides a tool closer to the needs of practitioners in terms of reproducing the market quotes and allowing for independent local shocks in the different segments of the curve.
Highlights
The term structure of interest rates is the relationship between interest rates or bond yields and different terms or maturities
In this paper we model and forecast the Colombian term structure of interest rates using approximate yields that are estimated directly from the bonds, but are not interpolated, and we use a segmented Nelson-Siegel three factor model as proposed by (Almeida, Ardison, Kubudi, Simonsen, & Vicente, 2018)
Term structure models are important for the pricing of instruments that are part of trading and reporting activities in financial markets
Summary
The term structure of interest rates is the relationship between interest rates or bond yields and different terms or maturities. (Andreasen, Christensen, & Rudebush, 2019) with an arbitrage-free Nelson-Siegel model propose a one-step estimation approach that uses the directly observable bond prices in a non-linear state space model. (Nagy, 2019) provides an approach for term structure modelling that is based directly on the bonds and formulates a linearized state model for the dynamic Nelson-Siegel model They apply the methodology to US and Hungarian data; in the latter the challenge is the lack of sufficient bonds along the curve. In this paper we model and forecast the Colombian term structure of interest rates using approximate yields that are estimated directly from the bonds, but are not interpolated, and we use a segmented Nelson-Siegel three factor model as proposed by (Almeida, Ardison, Kubudi, Simonsen, & Vicente, 2018).
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