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Estimating and Fitting the Term Structure

The two previous chapters introduced and described a fraction of the most important research into interest rate models that has been carried out since the first model, presented by Oldrich Vasicek, appeared in 1977. These models can be used to price derivative securities, and equilibrium models can be used to assess fair value in the bond market. Before this can take place however a model must be fitted to the yield curve, or calibrated.1 In practice this is carried out on two ways; the most popular approach involves calibrating the model against market interest rates given by instruments such as cash Libor deposits, futures, swaps and bonds. The alternative method is to model the yield curve from the ...

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