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Copyright © 1996-2006
Investment Analytics
Interpolation Techniques
Why interpolate?
Straight line interpolation
Cubic spline interpolation
Basis spline interpolation
T1 Ri
R1
Ri = (1 − α ) R1 + αR2
Ti − T1
α=
T2 − T1
Ti Ti
(1−α ) α
⇒ Di = D1 T1
D2 T2
7.50%
Ri-1(t)
7.00%
6.50% Ri(t)
= ai(t-ti)3 + bi (t-ti)2 + ci (t-ti) + di
6.00%
5.50%
5.00%
0 200 400 600 800 1000 1200 1400 1600 1800 2000
8.00%
7.50%
7.00%
6.50%
Linear Interp on DF
6.00%
Linear Interp on R
5.50%
Cspline Interp on DF
5.00%
0 500 1000 1500 Days 2000
Knot Points
Copyright © 1996-2006 Investment Analytics Interpolation Techniques Slide: 20
Selection of Knot Points
Results can be sensitive to placing of knot
points
Unless there is an even distribution of bonds.
Important to have an equal number of bonds
with maturities between each knot point.
Reduces estimation error.
7.0%
6.5%
6.0%
5.5%
Spot
Forw ard
5.0%
0 500 1000 1500 2000 2500 3000
7%
7%
6%
6%
5%
5%
Spot Rate
4% Upper 95%
4% Low er 95%
3%
0 500 1000 1500 2000 2500 3000