Abstract
Many variations exist of yield curve modeling based on the exponential components framework, but most do not consider the generating process of the error term. In this paper, we propose a method of yield curve estimation using an instantaneous error term generated with a standard Brownian motion. First, we add an instantaneous error term to Nelson and Siegel’s instantaneous forward rate model [C.R. Nelson, A.F. Siegel, Parsimonious modeling of yield curves, Journal of Business 60 (1987) 473–489]. Second, after differencing multiperiod spot rate models transformed using Nelson and Siegel’s instantaneous forward rate model [C.R. Nelson, A.F. Siegel, Parsimonious modeling of yield curves, Journal of Business 60 (1987) 473–489], we obtain a model with serially uncorrelated error terms because of independent increment properties of Brownian motion. As the error term in this model is heteroskedastic and not serially correlated, we can apply weighted least squares estimation techniques. That is, this specification of the error term does not lead to incorrect estimation methods. In an empirical analysis, we compare the instantaneous forward rate curves estimated by the proposed method and an existing method. We find that the shape from the proposed estimation equation differ from the latter method when fluctuations in the interest rate data used for the estimation are volatile.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.