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A simple and general approach to fitting the discount curve under no-arbitrage constraints

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  • Fengler, Matthias R.
  • Hin, Lin-Yee
Abstract
We suggest a simple and general approach to fitting the discount curve under no-arbitrage constraints based on a penalized shape-constrained B-spline. The approach accommodates B-splines of any order and fitting both under the L1 and the L2 loss functions. An application to US STRIPS data from 2001–2015 suggests that polynomial splines of order three and four are mandatory to obtain reasonable fits. The choice of the loss function appears to be less relevant.

Suggested Citation

  • Fengler, Matthias R. & Hin, Lin-Yee, 2015. "A simple and general approach to fitting the discount curve under no-arbitrage constraints," Finance Research Letters, Elsevier, vol. 15(C), pages 78-84.
    • Handle: RePEc:eee:finlet:v:15:y:2015:i:c:p:78-84
    DOI: 10.1016/j.frl.2015.08.006
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    More about this item

    Keywords

    B-splines; Discount curve; No-arbitrage constraints; Monotone estimation; Yield curve;
    All these keywords.

    JEL classification:

    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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