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Keywords:

  • Arbitrage-free;
  • Nelson–Siegel;
  • Svensson extension;
  • Yield curve

Summary  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.