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OUR ECONOMY

Testing the Performance of Cubic Splines and Nelson-Siegel Model for Estimating the Zero-coupon Yield Curve

Eva Lorenčič

Abstract


Understanding the relationship between interest rates and term to maturity
of securities is a prerequisite for developing financial theory and evaluating
whether it holds up in the real world; therefore, such an understanding lies at the
heart of monetary and financial economics. Accurately fitting the term structure
of interest rates is the backbone of a smoothly functioning financial market,
which is why the testing of various models for estimating and predicting the
term structure of interest rates is an important topic in finance that has received
considerable attention for many decades. In this paper, we empirically contrast
the performance of cubic splines and the Nelson-Siegel model by estimating the
zero-coupon yields of Austrian government bonds. The main conclusion that can
be drawn from the results of the calculations is that the Nelson-Siegel model
outperforms cubic splines at the short end of the yield curve (up to 2 years),
whereas for medium-term maturities (2 to 10 years) the fitting performance of
both models is comparable.


Keywords


Cubic splines; Nelson-Siegel; yield curve; zero-coupon bonds; term structure of interest rates

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