IDEAS home Printed from https://ideas.repec.org/a/sae/emffin/v13y2014i3p305-333.html
   My bibliography  Save this article

A Methodology to Estimate the Interest Rate Yield Curve in Illiquid Market

Author

Listed:
  • Fatma Chakroun

    (Fatma Chakroun, UR: MODESFI, Faculty of Management and Economics, Sfax, Tunisia. E-mail: fatima_chakroun@tunet.tn)

  • Fathi Abid

    (Fathi Abid, UR: MODESFI, Faculty of Management and Economics, Sfax, Tunisia. E-mail: fathi.abid@fsegs.rnu.tn)

Abstract

The aim of this article is to develop a methodology to estimate the interest rate yield curve and its dynamics in the Tunisian bond market, which is considered as an illiquid market with a low trading volume. To achieve this, first, we apply the cubic spline interpolation method to deal with the missing observation problem. Second, we focus on the work of Vasicek ( 1977 ) and Cox-Ingersoll and Ross (CIR) (1985), we estimate each model and discuss its performance in predicting the dynamics of the interest rate yield curve using ordinary least squares (OLS) and maximum likelihood estimation (MLE) methods. The data sample consists of Treasury bond prices for the period from 14 July 2004 to 10 September 2012 collected from over the counter market. This assessment is done by Matlab software using the specified algorithms. The results suggest that the cubic spline method is accurate for construction of the average interest rate yield curve. Then, the estimation of Vasicek ( 1977 ) and CIR (1985) models generate an upward sloping yield curves and the Vasicek ( 1977 ) model shows more ability to replicate the stylised facts of the short-term interest rates in the Tunisian bond market. Finally, the forecasting of the yield curve predicts an economic growth in the future characterised by a higher inflation. JEL Classification: G12

Suggested Citation

  • Fatma Chakroun & Fathi Abid, 2014. "A Methodology to Estimate the Interest Rate Yield Curve in Illiquid Market," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 13(3), pages 305-333, December.
    • Handle: RePEc:sae:emffin:v:13:y:2014:i:3:p:305-333
    DOI: 10.1177/0972652714552040
    as

    Download full text from publisher

    File URL: https://journals.sagepub.com/doi/10.1177/0972652714552040
    Download Restriction: no
    File URL: https://libkey.io/10.1177/0972652714552040?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Brennan, Michael J. & Schwartz, Eduardo S., 1982. "An Equilibrium Model of Bond Pricing and a Test of Market Efficiency," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 17(3), pages 301-329, September.
    2. de Munnik, Jeroen F. J. & Schotman, Peter C., 1994. "Cross-sectional versus time series estimation of term structure models: empirical results for the Dutch bond market," Journal of Banking & Finance, Elsevier, vol. 18(5), pages 997-1025, October.
    3. Gibbons, Michael R & Ramaswamy, Krishna, 1993. "A Test of the Cox, Ingersoll, and Ross Model of the Term Structure," The Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 619-658.
    4. Gallant, A. Ronald & Tauchen, George, 1996. "Which Moments to Match?," Econometric Theory, Cambridge University Press, vol. 12(4), pages 657-681, October.
    5. 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.
    6. Chan, K C, et al, 1992. "An Empirical Comparison of Alternative Models of the Short-Term Interest Rate," Journal of Finance, American Finance Association, vol. 47(3), pages 1209-1227, July.
    7. Chi Xie & Hui Chen & Xiang Yu, 2006. "Yield Curve Estimation In The Illiquid Market: Framework, Models And Empirical Study," International Journal of Information Technology & Decision Making (IJITDM), World Scientific Publishing Co. Pte. Ltd., vol. 5(03), pages 467-481.
    8. Stanton, Richard, 1997. "A Nonparametric Model of Term Structure Dynamics and the Market Price of Interest Rate Risk," Journal of Finance, American Finance Association, vol. 52(5), pages 1973-2002, December.
    9. Brown, Stephen J & Dybvig, Philip H, 1986. "The Empirical Implications of the Cox, Ingersoll, Ross Theory of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 41(3), pages 617-630, July.
    10. David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305, World Scientific Publishing Co. Pte. Ltd..
    11. C. Emre Alper & Aras Akdemir & Kazim Kazimov, 2004. "Estimating the Term Structure of Government Securities in Turkey," Working Papers 2004/03, Bogazici University, Department of Economics.
    12. Ait-Sahalia, Yacine, 1996. "Testing Continuous-Time Models of the Spot Interest Rate," The Review of Financial Studies, Society for Financial Studies, vol. 9(2), pages 385-426.
    13. Longstaff, Francis A & Schwartz, Eduardo S, 1992. "Interest Rate Volatility and the Term Structure: A Two-Factor General Equilibrium Model," Journal of Finance, American Finance Association, vol. 47(4), pages 1259-1282, September.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Suresh M. Sundaresan, 2000. "Continuous‐Time Methods in Finance: A Review and an Assessment," Journal of Finance, American Finance Association, vol. 55(4), pages 1569-1622, August.
    2. repec:wyi:journl:002108 is not listed on IDEAS
    3. Zongwu Cai & Yongmiao Hong, 2013. "Some Recent Developments in Nonparametric Finance," Working Papers 2013-10-14, Wang Yanan Institute for Studies in Economics (WISE), Xiamen University.
    4. Gong, Fangxiong & Remolona, Eli M, 1997. "Two Factors along the Yield Curve," The Manchester School of Economic & Social Studies, University of Manchester, vol. 65(0), pages 1-31, Supplemen.
    5. Cai, Zongwu & Hong, Yongmiao, 2003. "Nonparametric Methods in Continuous-Time Finance: A Selective Review," SFB 373 Discussion Papers 2003,15, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    6. Boero, G. & Torricelli, C., 1996. "A comparative evaluation of alternative models of the term structure of interest rates," European Journal of Operational Research, Elsevier, vol. 93(1), pages 205-223, August.
    7. Gil-Bazo Javier & Rubio Gonzalo, 2004. "A Nonparametric Dimension Test of the Term Structure," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 8(3), pages 1-28, September.
    8. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    9. repec:wyi:journl:002109 is not listed on IDEAS
    10. Jiang, George J., 1997. "A generalized one-factor term structure model and pricing of interest rate derivative securities," Research Report 97A34, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
    11. Dennis Kristensen, 2004. "A Semiparametric Single-Factor Model of the Term Structure," FMG Discussion Papers dp501, Financial Markets Group.
    12. repec:dgr:rugsom:97a34 is not listed on IDEAS
    13. Antonio Mele, 2003. "Fundamental Properties of Bond Prices in Models of the Short-Term Rate," The Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 679-716, July.
    14. Gibson, Rajna & Lhabitant, Francois-Serge & Talay, Denis, 2010. "Modeling the Term Structure of Interest Rates: A Review of the Literature," Foundations and Trends(R) in Finance, now publishers, vol. 5(1–2), pages 1-156, December.
    15. de Jong, Frank, 2000. "Time Series and Cross-Section Information in Affine Term-Structure Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 18(3), pages 300-314, July.
    16. Juan M. Moraleda & Ton Vorst, 1996. "The Valuation of Interest Rate Derivatives: Empirical Evidence from the Spanish Market," Tinbergen Institute Discussion Papers 96-170/2, Tinbergen Institute.
    17. Berardi, Andrea, 1995. "Estimating the Cox, ingersoll and Ross model of the term structure: a multivariate approach," Ricerche Economiche, Elsevier, vol. 49(1), pages 51-74, March.
    18. Robert Faff & Sirimon Treepongkaruna, 2013. "A re-examination of the empirical performance of the Longstaff and Schwartz two-factor term structure model using real yield data," Australian Journal of Management, Australian School of Business, vol. 38(2), pages 333-352, August.
    19. Qiang Dai & Kenneth Singleton, 2003. "Term Structure Dynamics in Theory and Reality," The Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 631-678, July.
    20. Constantin Mellios, 2001. "Valuation of Interest Rate Options in a Two-Factor Model of the Term Structure of Interest Rate," Working Papers 2001-1, Laboratoire Orléanais de Gestion - université d'Orléans.
    21. Josheski Dushko & Apostolov Mico, 2021. "Equilibrium Short-Rate Models Vs No-Arbitrage Models: Literature Review and Computational Examples," Econometrics. Advances in Applied Data Analysis, Sciendo, vol. 25(3), pages 42-71, September.
    22. Lioui, Abraham & Poncet, Patrice, 2004. "General equilibrium real and nominal interest rates," Journal of Banking & Finance, Elsevier, vol. 28(7), pages 1569-1595, July.
    23. Kristensen, Dennis, 2004. "Estimation in two classes of semiparametric diffusion models," LSE Research Online Documents on Economics 24739, London School of Economics and Political Science, LSE Library.

    More about this item

    Keywords

    Illiquid market; interest rate yield curve; cubic spline; Vasicek (1977) model; CIR (1985) model; OLS; MLE;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:sae:emffin:v:13:y:2014:i:3:p:305-333. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: SAGE Publications (email available below). General contact details of provider: http://www.ifmr.ac.in .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.