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Estimating Corporate Yield Curves

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  • Antionio Diaz

    () (Universidad de Castilla-La Mancha - Spain)

  • Frank Skinner

    () (ICMA Centre, University of Reading)

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    Abstract

    This paper represents the first study of retail deposit spreads of UK financial institutions using stochastic interest rate modelling and the market comparable approach. By replicating quoted fixed deposit rates using the Black Derman and Toy (1990) stochastic interest rate model, we find that the spread between fixed and variable rates of interest can be modeled (and priced) using an interest rate swap analogy. We also find that we can estimate an individual bank deposit yield curve as a spread off a benchmark yield curve. This suggests that we can price a particular bank’s products using arbitrage free interest rate methods since a basic input would be an estimate of the individual bank’s yield curve. Finally, we are able to suggest that the libor/swap is the best benchmark yield curve to estimate an individual bank deposit yield curve.

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    File URL: http://www.icmacentre.ac.uk/pdf/discussion/DP2001-01.pdf
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    Bibliographic Info

    Paper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2001-01.

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    Length: 20 pages
    Date of creation: 2001
    Date of revision:
    Handle: RePEc:rdg:icmadp:icma-dp2001-01

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    Postal: PO Box 218, Whiteknights, Reading, Berks, RG6 6AA
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    Fax: +44 (0) 118 975 0236
    Web page: http://www.henley.reading.ac.uk/
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    Related research

    Keywords: Credit Risk; Yield Curves; Credit Derivatives;

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    References

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    1. Shea, Gary S., 1984. "Pitfalls in Smoothing Interest Rate Term Structure Data: Equilibrium Models and Spline Approximations," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(03), pages 253-269, September.
    2. Edwin J. Elton & T. Clifton Green, 1998. "Tax and Liquidity Effects in Pricing Government Bonds," Journal of Finance, American Finance Association, vol. 53(5), pages 1533-1562, October.
    3. Vasicek, Oldrich A & Fong, H Gifford, 1982. " Term Structure Modeling Using Exponential Splines," Journal of Finance, American Finance Association, vol. 37(2), pages 339-48, May.
    4. Edwin J. Elton, 2001. "Explaining the Rate Spread on Corporate Bonds," Journal of Finance, American Finance Association, vol. 56(1), pages 247-277, 02.
    5. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
    6. Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
    7. Sarig, Oded & Warga, Arthur, 1989. "Bond Price Data and Bond Market Liquidity," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 367-378, September.
    8. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October.
    9. McCulloch, J Huston, 1975. "The Tax-Adjusted Yield Curve," Journal of Finance, American Finance Association, vol. 30(3), pages 811-30, June.
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    Citations

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    Cited by:
    1. Frank Skinner & Nicholas Papageorgiou, 2001. "Credit Spreads and the Treasury Zero Coupon Spot Curve," ICMA Centre Discussion Papers in Finance icma-dp2001-06, Henley Business School, Reading University, revised Jul 2002.
    2. Manzoni, Katiuscia, 2004. "Modeling Eurobond credit ratings and forecasting downgrade probability," International Review of Financial Analysis, Elsevier, vol. 13(3), pages 277-300.
    3. Diaz, Antonio & Merrick, John Jr. & Navarro, Eliseo, 2006. "Spanish Treasury bond market liquidity and volatility pre- and post-European Monetary Union," Journal of Banking & Finance, Elsevier, vol. 30(4), pages 1309-1332, April.

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