Exponentials, Polynomials, and Fourier Series: More Yield Curve Modelling at the Bank of Canada

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This paper continues the work started by Bolder and Stréliski (1999) and considers two alternative classes of models for extracting zero-coupon and forward rates from a set of observed Government of Canada bond and treasury-bill prices. The first class of term-structure estimation methods follows from work by Fisher, Nychka, and Zervos (1994), Anderson and Sleath (2001), and Waggoner (1997). This approach employs a B-spline basis for the space of cubic splines to fit observed coupon-bond prices—as a consequence, we call these the spline-based models. This approach includes a penalty in the generalized least-squares objective function—following from Waggoner (1997)—that imposes the desired level of smoothness into the term structure of interest rates. The second class of methods is called function-based and includes variations on the work of Li et al. (2001), which uses linear combinations of basis functions, defined over the entire term-to-maturity spectrum, to fit the discount function. This class of function-based models includes the model proposed by Svensson (1994). In addition to a comprehensive discussion of these models, the authors perform an extensive comparison of these models' performance in the Canadian marketplace.

DOI: https://doi.org/10.34989/swp-2002-29