Advanced Search
MyIDEAS: Login to save this paper or follow this series

Testing term structure estimation methods

Contents:

Author Info

  • Robert R. Bliss
Registered author(s):

    Abstract

    This paper tests and compares five distinct methods for estimating the term structure. The Unsmoothed Fama-Bliss method is an iterative method by which the discount rate function is built up by computing the forward rate necessary to price successively longer maturity bonds. The Smoothed Fama-Bliss "smooths out" these discount rates by fitting an approximating function to the "unsmoothed" rates. The McCulloch method fits a cubic spline to the discount function using an implicit smoothness penalty, while the Fisher-Nychka-Zervos method fits a cubic spline to the forward rate function and makes the smoothness penalty explicit. Lastly, the Extended Nelson-Siegel method, introduced in this paper, fits an exponential approximation of the discount rate function directly to bond prices. ; The tests demonstrate the dangers of in-sample goodness-of-fit as the sole criterion for judging term structure estimation methods. A series of residual analysis tests are introduced to detect misspecification of the underlying pricing equation relating the term structure to bond prices. These tests establish the presence of unspecified, but nonetheless systematic, omitted factors in the prices of long maturity notes and bonds. ; Comparisons of the five term structure estimation methods using these parametric and non-parametric tests finds that the Unsmoothed Fama-Bliss does best overall. Differences with some alternatives may not be economically significant given the much larger number of parameters this method estimates. Users seeking a parsimonious representation of the term structure should consider either the Smoothed Fama-Bliss or the Extended Nelson-Siegel methods. One method was found to be unacceptable. The Fisher-Nychka-Zervos cubic spline method performs poorly relative to the alternatives, both in- and out-of-sample. Furthermore, it systematically misprices short maturity issues and suffers from instability in the estimated term structure.

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://www.frbatlanta.org//filelegacydocs/Wp9612a.pdf
    Download Restriction: no

    Bibliographic Info

    Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 96-12.

    as in new window
    Length:
    Date of creation: 1996
    Date of revision:
    Publication status: Published in Advances in Futures and Options Research, 1997
    Handle: RePEc:fip:fedawp:96-12

    Contact details of provider:
    Postal: 1000 Peachtree St., N.E., Atlanta, Georgia 30309
    Phone: 404-521-8500
    Email:
    Web page: http://www.frbatlanta.org/
    More information through EDIRC

    Order Information:
    Email:

    Related research

    Keywords: Financial markets ; Interest rates ; Prices;

    References

    No references listed on IDEAS
    You can help add them by filling out this form.

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as in new window

    Cited by:
    1. Dupacova, Jitka & Bertocchi, Marida, 2001. "From data to model and back to data: A bond portfolio management problem," European Journal of Operational Research, Elsevier, vol. 134(2), pages 261-278, October.
    2. David Backus & Silverio Foresi & Abon Mozumdar & Liuren Wu, 1998. "Predictable Changes in Yields and Forward Rates," NBER Working Papers 6379, National Bureau of Economic Research, Inc.
    3. Morini,S., 2003. "Estimación de la curva de tipos cupón-cero con polinomios de Legendre," Estudios de Economía Aplicada, Estudios de Economía Aplicada, vol. 21, pages 363-375, Agosto.
    4. Robert R. Bliss & Ehud I. Ronn, 1997. "Callable U.S. Treasury bonds: optimal calls, anomalies, and implied volatilities," Working Paper 97-1, Federal Reserve Bank of Atlanta.
    5. Kathlyn Lucia & Stephanie Price & Edwin Wong & Richard Startz, 2008. "The Changing Relation Between the Canadian and U.S. Yield Curves," Working Papers UWEC-2008-05, University of Washington, Department of Economics.
    6. Gonzalo Cortazar & Eduardo S. Schwartz & Lorenzo F. Naranjo, 2007. "Term-structure estimation in markets with infrequent trading," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 12(4), pages 353-369.
    7. David Jamieson Bolder & Scott Gusba, 2002. "Exponentials, Polynomials, and Fourier Series: More Yield Curve Modelling at the Bank of Canada," Working Papers 02-29, Bank of Canada.
    8. Refet S. Gürkaynak & Brian Sack & Jonathan H. Wright, 2006. "The U.S. Treasury yield curve: 1961 to the present," Finance and Economics Discussion Series 2006-28, Board of Governors of the Federal Reserve System (U.S.).
    9. Brennan, Michael J. & Xia, Yihong, 2004. "International Capital Markets and Foreign Exchange Risk," University of California at Los Angeles, Anderson Graduate School of Management qt53z0s29k, Anderson Graduate School of Management, UCLA.
    10. Silverio Foresi & Alessandro Penati & George Pennacchi, 1997. "Estimating the cost of U.S. indexed bonds," Working Paper 9701, Federal Reserve Bank of Cleveland.
    11. Refet S. Gürkaynak & Brian Sack & Jonathan H. Wright, 2008. "The TIPS yield curve and inflation compensation," Finance and Economics Discussion Series 2008-05, Board of Governors of the Federal Reserve System (U.S.).
    12. Cortazar, Gonzalo & Schwartz, Eduardo S. & Naranjo, Lorezo, 2003. "Term Structure Estimation in Low-Frequency Transaction Markets: A Kalman Filter Approach with Incomplete Panel-Data," University of California at Los Angeles, Anderson Graduate School of Management qt56h775cz, Anderson Graduate School of Management, UCLA.
    13. George J. Hall & Thomas J. Sargent, 1997. "Accounting for the federal government's cost of funds," Economic Perspectives, Federal Reserve Bank of Chicago, issue Jul, pages 18-28.

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:fip:fedawp:96-12. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Meredith Rector).

    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 references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link 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 profile, as there may be some citations waiting for confirmation.

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