A Hybrid Spline-Based Parametric Model for the Yield Curve

48 Pages Posted: 14 Jan 2017 Last revised: 19 Jul 2017

See all articles by Adriano Faria

Adriano Faria

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finan├žas

Caio Almeida

Getulio Vargas Foundation ; Princeton University

Date Written: July 17, 2017

Abstract

Empirical evidence indicates that both nominal and real yield curves in important markets have segmentation between their short end and their longer-maturity segments. This segmentation might affect term structure estimation, introducing distortions in longer-maturity yields, especially in parametric models. In order to deal with such segmentation, we propose a new model that combines the flexibility of spline functions with the parsimoniousness of a parametric four-factor exponential model. The short end of the yield curve is fitted using a B-spline function, while longer segments are captured by the parametric model. We illustrate the benefits of the proposed model for pricing and risk management purposes, using two examples: the real yield curve in the Brazilian government index-linked bond market, and the US Treasury nominal yield curve. We show that, in both markets, our model is simultaneously able to fit the yield curve well and to provide unbiased Value at Risk estimates for all tested portfolios of bonds, outperforming an important parametric benchmark model frequently adopted by central banks.

Keywords: Price index, Spline Models, Exponential Term Structure Models, Curve Fitting, Risk management

JEL Classification: C51, C58, G17

Suggested Citation

Faria, Adriano and Almeida, Caio, A Hybrid Spline-Based Parametric Model for the Yield Curve (July 17, 2017). Available at SSRN: https://ssrn.com/abstract=2898306 or http://dx.doi.org/10.2139/ssrn.2898306

Adriano Faria

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finan├žas ( email )

Praia de Botafogo 190/1125, CEP
Rio de Janeiro RJ 22253-900
Brazil

Caio Almeida (Contact Author)

Getulio Vargas Foundation ( email )

Praia de Botafogo 190, 11o andar
Botafogo
Rio de Janeiro, Rio de Janeiro 22250-900
Brazil
5521-37995827 (Phone)
5521-2553-8821 (Fax)

HOME PAGE: http://www.fgv.br/professor/calmeida/

Princeton University ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States

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