Question: Evaluating the Use of NSS Model for Yield Curve Fitting
I've recently attempted to model the yield curve using the Nelson-Siegel-Svensson (NSS) model by minimizing the sum of squared residuals. For this, I pulled a series of bonds from the same issuer, ranging from 1 to 25 years in maturity, all denominated in the same currency, senior unsecured, and with identical credit ratings.
After fitting the NSS model, I observed that:
- Some quoted yields lie above the NSS curve,
- Some lie below,
- And some align closely with the fitted curve.
I have a few questions regarding methodology and interpretation:
- Is it appropriate to use Yield to Maturity (YTM) as the input for fitting the NSS model? Or should I be using spot rates or zero-coupon yields instead?
- Can I interpret bonds with YTM above the NSS curve as "cheap" and those below as "rich"? Or is this an oversimplification?
- Would a more accurate approach be to use the NSS model to interpolate spot rates for intermediate tenors, construct a spot curve, and then discount each bond's cash flows using these spot rates to assess fair value? I have a gut feeling this might be more robust than relying solely on YTM comparisons.
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