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Model-free nonparametric bounds for zero-coupon interest rates in bond markets without the no arbitrage principle

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  • Victor Lapshin

Abstract

Real-world market quotes of bonds can sometimes contradict the no arbitrage principle within the discounted cash flow model. This makes some kinds of no-arbitrage-based analyses impossible, e.g., inferring the bounds for the term structure of interest rates. Instead of using a more sophisticated model to account for pricing peculiarities, we propose a replacement for the no arbitrage principle. While being theoretically plausible, it does not get contradicted by the data – thus, we can infer the same kind of term structure bounds from it, even given the contradictions with the no arbitrage principle. Using a dataset of Russian sovereign bond quotes, we show that the no arbitrage inconsistency problem arises in 10–20% of cases and that the proposed approach successfully overcomes it.

Suggested Citation

  • Victor Lapshin, 2022. "Model-free nonparametric bounds for zero-coupon interest rates in bond markets without the no arbitrage principle," Applied Economics, Taylor & Francis Journals, vol. 54(2), pages 135-144, January.
    • Handle: RePEc:taf:applec:v:54:y:2022:i:2:p:135-144
    DOI: 10.1080/00036846.2021.1963659
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