Choosing the weighting coefficients for estimating the term structure from sovereign bonds

Victor Lapshin and Sofia Sohatskaya

International Review of Economics & Finance, 2020, vol. 70, issue C, 635-648

Abstract: Estimates of the term structure of interest rates depend heavily on the quality of the market data from which it is constructed. Estimated rates can be incorrect due to observation errors and omissions in the data. The usual way to deal with the heteroskedasticity of observation errors is by introducing weights in the fitting procedure. There is currently no consensus in the literature about the choice of such weights. We introduce a non-parametric bootstrap-based method of introducing observation errors drawn from the empirical distribution into the model data, which allows us to perform a comparison test of different weighting schemes without implicitly favoring one of the contesting models – a common design flaw in comparison studies. We use government bonds of several countries to show that realistic observation errors can distort the estimated yield curve. Moreover, we show that using different weights or other modifications of accounting for observation errors in bond price data doesn’t always improve the term structure estimates, and often only worsens the situation. Based on our comparison, we advise to either use equal weights or weights proportional to the inverse duration in practical applications.

Keywords: Term structure of interest rates; Zero-coupon yield curve; Bond prices; Weights; Cross-validation (search for similar items in EconPapers)
JEL-codes: E43 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S1059056020301805
Full text for ScienceDirect subscribers only

Related works:
Working Paper: CHOOSING THE WEIGHTING COEFFICIENTS FOR ESTIMATING THE TERM STRUCTURE FROM SOVEREIGN BONDS (2018)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:70:y:2020:i:c:p:635-648

DOI: 10.1016/j.iref.2020.08.011

Access Statistics for this article

International Review of Economics & Finance is currently edited by H. Beladi and C. Chen

More articles in International Review of Economics & Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().