Statistical Properties of Forward Libor Rates
historical forward rates are used to calibrate the lognormal forward rate model - as advocated by Hull and White (1999, 2000), Longstaff, Santa Clara and Schwartz (1999), Rebonato (1999a,b,c), Rebonato and Joshi (2001) and many others - a Libor yield curve needs to be fit to the available data on spot libor rates, forward rate agreements (FRAs) or futures, and swap rates. This paper compares the statistical properties of the time series of forward rates that are obtained using three different yield curve fitting techniques. Introduced by McCulloch (1975), Steely (1991) and Svensson (1994), each of the three techniques is well known for its application to the construction of bond yield curves. Our work focuses on the eigenstructure of estimated forward rate correlation matrices. These are shown to be dominated by the semi-parametric or parametric form that is used in the yield curve model. The spectral decomposition of forward rate correlation - and covariance - matrices is considered in some detail, and in particular we test the common principal component hypothesis of Flury (1988), which has been applied to the lognormal forward rate model by Alexander (2003). We conclude that, if historical data are used to calibrate the lognormal forward rate model, it is best to use Svensson forward rate correlation matrices. However, the empirical evidence is strongly in favour of the common principal component hypothesis, where the three principal eigenvectors in all correlation matrices of the same dimension are identical. Hence we further conclude that a parsimonious parameterisation of forward rate correlations is possible, and this allows for direct calibration of forward rate correlations to market data, so historical data are not necessary.
|Date of creation:||Jan 2003|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: +44 (0) 118 378 8226
Fax: +44 (0) 118 975 0236
Web page: http://www.henley.reading.ac.uk/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Miltersen, Kristian R & Sandmann, Klaus & Sondermann, Dieter, 1997.
" Closed Form Solutions for Term Structure Derivatives with Log-Normal Interest Rates,"
Journal of Finance,
American Finance Association, vol. 52(1), pages 409-30, March.
- Miltersen, K. & K. Sandmann & D. Sondermann, 1994. "Closed Form Solutions for Term Structure Derivatives with Log-Normal Interest Rates," Discussion Paper Serie B 308, University of Bonn, Germany.
- Farshid Jamshidian, 1997. "LIBOR and swap market models and measures (*)," Finance and Stochastics, Springer, vol. 1(4), pages 293-330.
When requesting a correction, please mention this item's handle: RePEc:rdg:icmadp:icma-dp2003-03. 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: (Ed Quick)
If references are entirely missing, you can add them using this form.