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Fitting Parsimonious Yield Curve Models to Australian Coupon Bond Data

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Abstract

This study uses a unique data set on Australian coupon bonds to test a number of yield curve models. A non-linear least squares technique is employed to directly fit four alternative, zero coupon, forward rate, yield curve models to the data. The four yield curve models tested were two, 4-parameter polynomial curves and two 3-parameter models including a Laguerre function. We show that a fourth order polynomial with the cubic term omitted best fits the data. This preferred model provides good estimates of both the forward and spot rate curves as well as producing volatility structures that accorded with our a priori expectation. The preferred, fourth order polynomial model is used as the basis of a market trading strategy. In this strategy, a model predicted underpriced bonds are purchased and a model predicted overpriced bonds are sold. This strategy is shown to be superior to a random trading strategy. There is however, little evidence of market inefficiency as transaction costs account for any profit generated by the strategy.

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  • Ben Hunt, 1995. "Fitting Parsimonious Yield Curve Models to Australian Coupon Bond Data," Working Paper Series 51, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    • Handle: RePEc:uts:wpaper:51
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    Cited by:

    1. Leo Krippner, 2003. "Modelling the Yield Curve with Orthonormalised Laguerre Polynomials: A Consistent Cross-Sectional and Inter-Temporal Approach," Working Papers in Economics 03/02, University of Waikato.
    2. Ben Hunt & Chris Terry, 1998. "Zero-Coupon Yield Curve Estimation: A Principal Component, Polynomial Approach," Working Paper Series 81, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    3. Leo Krippner, 2003. "Modelling the Yield Curve with Orthonomalised Laguerre Polynomials: An Intertemporally Consistent Approach with an Economic Interpretation," Working Papers in Economics 03/01, University of Waikato.
    4. Leo Krippner, 2006. "A Theoretically Consistent Version of the Nelson and Siegel Class of Yield Curve Models," Applied Mathematical Finance, Taylor & Francis Journals, vol. 13(1), pages 39-59.
    5. Leo Krippner, 2005. "An Intertemporally-Consistent and Arbitrage-Free Version of the Nelson and Siegel Class of Yield Curve Models," Working Papers in Economics 05/01, University of Waikato.

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