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 arbitrage-free generalized Nelson-Siegel model and demonstrate its tractability and good in-sample fit.
Diebold, Francis X., Glenn D. Rudebusch, and Jens H. E. Christensen. 2008. “An Arbitrage-Free Generalized Nelson-Siegel Term Structure Model,” Federal Reserve Bank of San Francisco Working Paper 2008-07. Available at https://doi.org/10.24148/wp2008-07