Evolving Yield Curves in the Real-World Measures: A Semi-Parametric Approach

Abstract

In this paper, we show how to evolve a yield curve over time horizons of the order of years using a simple but effective semi-parametric method. The proposed technique preserves in the limit all the eigenvalues and eigenvectors of the observed changes in yields. It also recovers in a satisfactory way several important statistical features (unconditional variance, serial autocorrelation, distribution of curvatures, eigenvectors) of the real-world data. A simple financial explanation can be provided for the methodology. The possible financial applications are discussed.

Keywords: Yield curve, semi-parametric, eigenvalues, eigenvectors