A Smooth Shadow-Rate Dynamic Nelson-Siegel Model for Yields at the Zero Lower Bound
Daan Opschoor  1@  , Michel Van Der Wel  2  
1 : Erasmus University Rotterdam  -  Website
2 : Erasmus University Rotterdamm

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 transition 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.


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