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Title: A smooth shadow-rate dynamic Nelson-Siegel model of the yield curve at the zero lower bound Authors:  Michel van der Wel - Erasmus University Rotterdam (Netherlands)
Daan Opschoor - Erasmus University Rotterdam (Netherlands) [presenting]
Abstract: A smooth shadow-rate version of the dynamic Nelson-Siegel (DNS) model is proposed 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 and easily permits the implementation of readily available DNS extensions such as time-varying parameters, 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 shadow-rate affine term structure models.