An arbitrage-free generalized Nelson--Siegel term structure model

The Svensson generalization of the popular Nelson--Siegel term structure model is widely used by practitioners and central banks. Unfortunately, like the original Nelson--Siegel specification, this generalization, in its dynamic form, does not enforce arbitrage-free consistency over time. Indeed, we show that the factor loadings of the Svensson generalization cannot be obtained in a standard finance arbitrage-free affine term structure representation. Therefore, we introduce a closely related generalized Nelson--Siegel model on which the no-arbitrage condition can be imposed. We estimate this new AFGNS model and demonstrate its tractability and good in-sample fit. Copyright The Author(s). Journal compilation Royal Economic Society 2009