Analyzing China’s Term Structure of Interest Rates Using VAR and Nelson-Siegel Model

Abstract

China’s bonds market has developed rapidly in recent years. A further study of interest rate term structure is essential. Nelson-Siegel model is widely used to fit interest rate term structure around the world. In this essay, we try to find out whether Nelson-Siegel model is efficiency in China, and which model is most efficient among some typical variants of Nelson-Siegel model. After brief theoretical introduction, we conduct empirical analysis, which contains two sections. In the first session, we focus on fitting Chinese interest rate term structure using Nelson-Siegel model, and fitting efficiency turns out to be pretty good. In the second section, we establish a VAR model with macroeconomic variables to predict parameters in Nelson-Siegel model, and use the combination of VAR and NS model to predict interest rate term structure in 2019 and 2020 respectively. Also, in terms of prediction efficiency, VAR (Macro)-NS model performs better than both VAR-NS model without macroeconomic variables and simple NS model.