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Advanced Fixed Income Analysis, 2nd Edition by Michele Lizzio, Moorad Choudhry

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Chapter 5

Fitting the Term Structure

Abstract

The Chapters 3 and 4 introduced the most important interest-rate models in which they can be used to price bonds. However, they give a theoretical estimation of the yield curve, in which can be different with the one observed in the market. Therefore, these models must be fitted with the market yield curve in order to obtain the parity between fair value and market price. This chapter reviews the most common techniques employed to fit the yield curve from market inputs using an interpolation model. There are accessible descriptions and illustrations of the cubic polynomial and cubic spline. There is also an in-depth section about nonparametric curve-fitting methods, including Nelson and Siegel. ...

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