This research paper analyzes the profitability of trading rules based on term structure residuals in the German government bond market. Thereby, the term structure is estimated using the Vasiček (1977), Svensson (1994) and the Nelson-Siegel (1987) model. The resulting curves are used to price outstanding bonds in the market. A simple moving average technique is applied to the pricing errors that denote the differences between the actual bond and the modeled prices. The profitability of these trading rules is then compared with a buy and hold portfolio and a German government bond index. Results are similar across models and indicate that the trading strategies are only able to produce abnormal returns when trading signals are triggered based on pricing errors that substantially deviate from their historical average. Nevertheless, not one model emerges as the best performing or worst performing model. Rather, the performance of the models depend and vary based on the trading strategy applied, the allowed weight of a position in the portfolio and the size of the deviation of a pricing error from its average value that triggers a trading signal. Hence, this study generally rejects the idea that trading rules based on term structure residuals in the German government bond market are profitable. Nevertheless, results indicate that it is valuable for a fixed income investor to factor technical trading indicators into his investment decision making process.

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