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Fitting Parsimonious Yield Curve Models to Australian Coupon Bond Data

This study uses a unique data set on Australian coupon bonds to test a number of yield curve models. A non-linear least squares technique is employed to directly fit four alternative, zero coupon, forward rate, yield curve models to the data. The four yield curve models tested were two, 4-parameter polynomial curves and two 3-parameter models including a Laguerre function. We show that a fourth order polynomial with the cubic term omitted best fits the data. This preferred model provides good estimates of both the forward and spot rate curves as well as producing volatility structures that accorded with our a priori expectation. The preferred, fourth order polynomial model is used as the basis of a market trading strategy. In this strategy, a model predicted underpriced bonds are purchased and a model predicted overpriced bonds are sold. This strategy is shown to be superior to a random trading strategy. There is however, little evidence of market inefficiency as transaction costs account for any profit generated by the strategy.

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Paper provided by Finance Discipline Group, UTS Business School, University of Technology, Sydney in its series Working Paper Series with number 51.

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Length: 17 pages
Date of creation: 01 Sep 1995
Handle: RePEc:uts:wpaper:51
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  1. Vasicek, Oldrich A & Fong, H Gifford, 1982. " Term Structure Modeling Using Exponential Splines," Journal of Finance, American Finance Association, vol. 37(2), pages 339-348, May.
  2. R. Bhar & C. Chiarella, 1997. "Transformation of Heath?Jarrow?Morton models to Markovian systems," The European Journal of Finance, Taylor & Francis Journals, vol. 3(1), pages 1-26.
  3. McCulloch, J Huston, 1971. "Measuring the Term Structure of Interest Rates," The Journal of Business, University of Chicago Press, vol. 44(1), pages 19-31, January.
  4. McCulloch, J Huston, 1975. "The Tax-Adjusted Yield Curve," Journal of Finance, American Finance Association, vol. 30(3), pages 811-830, June.
  5. David Durand, 1942. "Basic Yields of Corporate Bonds, 1900-1942," NBER Chapters,in: Basic Yields of Corporate Bonds, 1900-1942, pages 1-40 National Bureau of Economic Research, Inc.
  6. David Durand, 1942. "Basic Yields of Corporate Bonds, 1900-1942," NBER Books, National Bureau of Economic Research, Inc, number dura42-1, December.
  7. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-489, October.
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