Global Yield Curve Dynamics and Interactions: A Dynamic Nelson-Siegel Approach

Abstract

The popular Nelson-Siegel (1987) yield curve is routinely fit to cross sections of intra-country bond yields, and Diebold and Li (2006) have recently proposed a dynamized version. In this paper we extend Diebold-Li to a global context, modeling a potentially large set of country yield curves in a framework that allows for both global and country-specific factors. In an empirical analysis of term structures of government bond yields for the Germany, Japan, the U.K. and the U.S., we find that global yield factors do indeed exist and are economically important, generally explaining significant fractions of country yield curve dynamics, with interesting differences across countries.

How arbitrage-free is the Nelson–Siegel model?

“…See, among others, Nelson and Siegel (1987), Diebold and Li (2006), Diebold, Rudebusch and Aruoba (2006), Diebold, Ji and Yue (2007), Duffee (2006), Ang and Piazzesi (2003), Bansal and Zhou (2002), and Dai and Singleton (2000 Our goal is to test whether the Nelson-Siegel model in equations (2) to (4) is statistically different from the no-arbitrage model in equations (6) to (12). Since the estimated factors, X NS t are the same for both models we can formulate our hypotheses is the following way: …”

A Global Model of International Yield Curves: No-Arbitrage Term Structure Approach

“…But additional factors are required to explain all three country yield curves jointly (Table 2). So, taking our motivation from Diebold et al (2008), we introduce a local factor to account for the variation in yields across countries. In each case, however, we use three factors to model the individual country variation yields.…”

“…More recently, researchers have documented that international yield curves exhibit common variation. In particular, empirical analysis of yield curves for Germany, the UK, the USA and Japan by Diebold et al (2008) provides evidence that 'global yield factors do indeed exist and are economically important, explaining significant fractions of country yield curve dynamics, with interesting differences across countries'. In a similar way to Diebold et al (2008), we model international yield curves in a unified framework that allows for both global and local factors.…”

“…In particular, empirical analysis of yield curves for Germany, the UK, the USA and Japan by Diebold et al (2008) provides evidence that 'global yield factors do indeed exist and are economically important, explaining significant fractions of country yield curve dynamics, with interesting differences across countries'. In a similar way to Diebold et al (2008), we model international yield curves in a unified framework that allows for both global and local factors. Importantly, in contrast to their work, our approach is to model international yield curves jointly in a no-arbitrage framework, which allows us to analyse whether yield curves move because of changes in expectations or because of term premia dynamics.…”

Time‐varying yield curve dynamics and monetary policy

“…Recent examples include, Diebold, Rudebusch and Aruoba (2006) and for the US and Lindholdt et al Rudebusch and Wu (2006) and Diebold, Li and Yue (2006) show that the dynamics of the yield curve (in the US and the UK) may have changed over time.…”