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Improving the Quality of the Input in the Term Structure Consistent Models

Author

Listed:
  • Javier Giner

    (University of La Laguna, Tenerife)

  • Sandra Morini

    (University of La Laguna, Tenerife)

Abstract

In finance, getting an accurate estimation of the term structure of interest rates is essential because this information is often used as input by other pricing financial models. In this paper, we point out the importance of selecting a suitable estimation of the term structure of interest rates. To show this fact, we use the Spanish Bond Market to estimate the initial interest rate and forward curves for one day, by using both McCulloch (1975) cubic polynomial splines, and Legendre's polynomials (Morini, 1998). We use these curves as input for pricing pure discount bonds with the Ho and Lee (1986) and Hull and White (1990) models. Then, we find the important result that using an inadequate interest rate curve affects dramatically the behaviour of the dynamic term structure models and, consequently, the estimation of the asset pricing models

Suggested Citation

  • Javier Giner & Sandra Morini, 2001. "Improving the Quality of the Input in the Term Structure Consistent Models," CSEF Working Papers 70, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    • Handle: RePEc:sef:csefwp:70
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    File URL: http://www.csef.it/WP/wp70.pdf
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    References listed on IDEAS

    as
    1. McCulloch, J Huston, 1971. "Measuring the Term Structure of Interest Rates," The Journal of Business, University of Chicago Press, vol. 44(1), pages 19-31, January.
    2. Ho, Thomas S Y & Lee, Sang-bin, 1986. "Term Structure Movements and Pricing Interest Rate Contingent Claims," Journal of Finance, American Finance Association, vol. 41(5), pages 1011-1029, December.
    3. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," The Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-592.
    4. McCulloch, J Huston, 1975. "The Tax-Adjusted Yield Curve," Journal of Finance, American Finance Association, vol. 30(3), pages 811-830, June.
    5. Chris Strickland, 1996. "A comparison of diffusion models of the term structure," The European Journal of Finance, Taylor & Francis Journals, vol. 2(1), pages 103-123.
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    More about this item

    Keywords

    Term structure of interest rates; dynamic consistent models;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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