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Developing a Practical Yield Curve Model: An Odyssey

29 Pages Posted: 7 Aug 2013  

M. A. H. Dempster

University of Cambridge - Centre for Financial Research; Cambridge Systems Associates Limited

Jack L. Evans

eValue FE

Elena Medova

University of Cambridge - Centre for Financial Research; Cambridge Systems Associates Limited

Date Written: September 30, 2012

Abstract

This paper describes the search for a yield curve model that embodies current research but will be used for product pricing, investment advice and asset liability management over long horizons. A variety of available 3-factor affine models are implemented and tested, often with surprising results. The existing model evaluation process leads to a new nonlinear model based on an observation of Black and possessing all the required stylized features for our applications. The examined alternatives all fail in some of these. The efficient implementation developed for the new yield curve model is expected to be the keystone of capital market models in the four major currencies and the paper concludes with some considerations in this direction.

Keywords: Capital markets, 3-factor affine yield curve models, long term horizons, low rate regimes, nonlinear Black model

JEL Classification: E43, E44, E47

Suggested Citation

Dempster, M. A. H. and Evans, Jack L. and Medova, Elena, Developing a Practical Yield Curve Model: An Odyssey (September 30, 2012). Available at SSRN: https://ssrn.com/abstract=2304372 or http://dx.doi.org/10.2139/ssrn.2304372

M. A. H. Dempster (Contact Author)

University of Cambridge - Centre for Financial Research ( email )

Centre for Mathematical Sciences
Wilberforce Road
Cambridge, CB3 0WA
United Kingdom

Cambridge Systems Associates Limited ( email )

5-7 Portugal Place
Cambridge, CB5 8AF
United Kingdom

Jack L. Evans

eValue FE ( email )

Lambourn Square
Newbury Business Park
Newbury, RG14
United Kingdom

Elena Medova

University of Cambridge - Centre for Financial Research ( email )

Centre for Mathematical Sciences
Wilberforce Road
Cambridge, CB3 0WA
United Kingdom

Cambridge Systems Associates Limited ( email )

5-7 Portugal Place
Cambridge, CB5 8AF
United Kingdom

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