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Journal of Advances in Economics and Finance
JAEF > Volume 1, Number 1, November 2016

Maximally Smooth Forward Rate Curves for Coupon Bearing Bonds

Download PDF  (830 KB)PP. 28-43,  Pub. Date:December 23, 2016
DOI: 10.22606/jaef.2016.11003

Author(s)
Hussain Abusaaq, Paul M. Beaumont, Yaniv Jerassy-Etzion
Affiliation(s)
Saudi Arabian Monetary Agency, Riyadh, Saudi Arabia; Department of Economics, Florida State Univeristy, Tallahassee, Florida 32306, United States; School of Economics and Business Administration, Ruppin Academic Center, Emek Hefer, Israel
Abstract
We present a fast and accurate algorithm to compute the maximally smooth instantaneous forward rate curve and the associated spot rate curve for the term structure of interest rates for coupon bearing bonds. The method produces zero pricing errors, constrains initial and terminal conditions of the spot and forward curves and produces the maximally smooth forward rate curve among the class of polynomial spline functions. The algorithm is simple enough to be quickly explained to traders and clients and flexible enough to be easily modified for different types of fixed income security markets. We illustrate the algorithm using on-the-run U.S. Treasury bonds for periods where the yield curve has a normal shape and also when it is inverted.
Keywords
Term structure of interest rates, yield curve, coupon stripping, curve interpolation, maximally smooth curves
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