Positive forward rates in the maximum smoothenss framework

DOI10.1080/14697680400000026MaRDI QIDQ4610229zbMATH OpenOpenAlexFDO

Authors Julián Manzano, Jörgen Blomvall

Publication date 15 January 2019

Published in Quantitative Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/math/0305307

zbMATH Keywords

maximum smoothness frameworknonlinerar dynamic programmingpositive forward ratesSwedish bond market

Mathematics Subject Classification ID

Dynamic programming (90C39) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: In this article we present a non-linear dynamic programming algorithm for the computation of forward rates within the maximum smoothness framework. The algorithm implements the forward rate positivity constraint for a one-parametric family of smoothness measures and it handles price spreads in the constraining dataset. We investigate the outcome of the algorithm using the Swedish Bond market showing examples where the absence of the positive constraint leads to negative interest rates. Furthermore we investigate the predictive accuracy of the algorithm as we move along the family of smoothness measures. Among other things we observe that the inclusion of spreads not only improves the smoothness of forward curves but also significantly reduces the predictive error.

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Cites work

• Asymptotics for and against cross-validation
• Dynamic programming and optimal control. Vol. 1.

Cited in

(6)

• Corporate hedging: an answer to the ``how question
• Measurement of interest rates using a convex optimization model
• Exact smooth term-structure estimation
• No-arbitrage bounds for the forward smile given marginals
• A CONSTRAINED LEAST SQUARE METHOD FOR ESTIMATING A SMOOTH, NONNEGATIVE FORWARD RATE SEQUENCE
• Construct Smith-Wilson risk-free interest rate curves with endogenous and positive ultimate forward rates

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