Fitting the Yield Curve
This chapter considers some of the techniques used to fit the model-derived term structure to the observed one. The Vasicek, Brennan-Schwartz, Cox-Ingersoll-Ross, and other models discussed in Chapter 4 made various assumptions about the nature of the stochastic process that drives interest rates in defining the term structure. The zero-coupon curves derived by those models differ from those constructed from observed market rates or the spot rates implied by market yields. In general, market yield curves have more-variable shapes than those derived by term-structure models. The interest rate models described in Chapter 4 must thus be calibrated to market yield curves. This is done in two ways: either the model ...

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