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Arbitrage Smoothing In Fitting A Sequence Of Yield Curves

Author

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  • PAUL A. BEKKER

    (Department of Economics, University of Groningen, P.O. Box 800, 9700 AV Groningen, The Netherlands)

  • KEES E. BOUWMAN

    (Econometric Institute, Erasmus University Rotterdam, P.O. Box 1738, 3000 DR Rotterdam, The Netherlands)

Abstract

Empirical modeling of the yield curve is often inconsistent with absence of arbitrage. In fact, many parsimonious models, like the popular Nelson-Siegel model, are inconsistent with absence of arbitrage. In other cases, arbitrage-free models are often used in inconsistent ways by recalibrating parameters that are assumed constant. For these cases, this paper introduces an arbitrage smoothing device to control arbitrage errors that arise in fitting a sequence of yield curves. The device is applied to the US term structure for the family of Nelson-Siegel curves. It is shown that the arbitrage smoothing device contributes to parameter stability and smoothness.

Suggested Citation

  • Paul A. Bekker & Kees E. Bouwman, 2009. "Arbitrage Smoothing In Fitting A Sequence Of Yield Curves," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 12(05), pages 577-588.
    • Handle: RePEc:wsi:ijtafx:v:12:y:2009:i:05:n:s0219024909005373
    DOI: 10.1142/S0219024909005373
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    References listed on IDEAS

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    1. David Bolder & David Stréliski, 1999. "Yield Curve Modelling at the Bank of Canada," Technical Reports 84, Bank of Canada.
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