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Fitting term structure of interest rates using B-splines: the case of Taiwanese Government bonds

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  • Bing-Huei Lin

Abstract

The B-spline curve fitting technique is one of the most popular empirical methodologies for estimating the term structure of interest rates, due to its stability and reliability in practical applications. This paper applies the B-spline technique to estimating the term structure for an important small-sized emerging bond market, the Taiwanese Government Bond (TGB) market. Regardless of the efficiency of the obsrved market data, several issues are investigated when applying this fitting technique. The application of the B-spline functions is first discussed to approximate the discount function, spot yield curve and forward yield curve respectively. The coupon payment effect on the TGB price is identified and is incorporated into the model estimation. A sensitivity analysis for the B-spline technique is performed with respect to changes in the within-sample knots, and a feasible method suggested for choosing the optimal knots within the approximation space in view of standard pricing error minimization. The results show that the B-spline methodology, when applied to discount fitting and spot fitting, is satisfactory in obtaining reliable term structure. It is also not very sensitive to some ad hoc choices in the model estimation.

Suggested Citation

  • Bing-Huei Lin, 2002. "Fitting term structure of interest rates using B-splines: the case of Taiwanese Government bonds," Applied Financial Economics, Taylor & Francis Journals, vol. 12(1), pages 57-75.
  • Handle: RePEc:taf:apfiec:v:12:y:2002:i:1:p:57-75
    DOI: 10.1080/09603100110088058
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    References listed on IDEAS

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    1. Mark Deacon & Andrew Derry, 1994. "Estimating the Term Structure of Interest Rates," Bank of England working papers 24, Bank of England.
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    Cited by:

    1. Leo Krippner, 2003. "Modelling the Yield Curve with Orthonormalised Laguerre Polynomials: A Consistent Cross-Sectional and Inter-Temporal Approach," Working Papers in Economics 03/02, University of Waikato.
    2. Victor A. Lapshin & Vadim Ya. Kaushanskiy, 2014. "A Nonparametric Method For Term Structure Fitting With Automatic Smoothing," HSE Working papers WP BRP 39/FE/2014, National Research University Higher School of Economics.
    3. Magdalena Massot Perelló & Juan M. Nave Pineda, 2003. "La hipótesis de las expectativas en el largo plazo: evidencia en el mercado español de deuda pública," Investigaciones Economicas, Fundación SEPI, vol. 27(3), pages 533-564, September.
    4. Wolfgang K. Härdle & Piotr Majer, 2016. "Yield curve modeling and forecasting using semiparametric factor dynamics," The European Journal of Finance, Taylor & Francis Journals, vol. 22(12), pages 1109-1129, September.
    5. Chiu, Nan-Chieh & Fang, Shu-Cherng & Lavery, John E. & Lin, Jen-Yen & Wang, Yong, 2008. "Approximating term structure of interest rates using cubic L1 splines," European Journal of Operational Research, Elsevier, vol. 184(3), pages 990-1004, February.
    6. J. Hirschberg & J. Lye & D.J. Slottje, 2005. "Alernative Forms for Restricted Regressions," Department of Economics - Working Papers Series 954, The University of Melbourne.
    7. Emma Berenguer-Carceles & Ricardo Gimeno & Juan M. Nave, 2012. "Estimation of the Term Structure of Interest Rates: Methodology and Applications," Working Papers 12.06, Universidad Pablo de Olavide, Department of Financial Economics and Accounting (former Department of Business Administration).
    8. Patrick Hagan & Graeme West, 2006. "Interpolation Methods for Curve Construction," Applied Mathematical Finance, Taylor & Francis Journals, vol. 13(2), pages 89-129.

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