Extracting Yield Curves from Bond Prices

Abstract

The clearest picture of the term structure of interest rates is obtained by looking at the yields of zero-coupon bonds of different maturities. However, in most countries almost all traded bonds are coupon bonds, not zero-coupon bonds. This chapter discusses methods to extract or estimate a zero-coupon yield curve from the prices of coupon bonds at a given point in time. In the U.S. and some other countries, zero-coupon bonds can be traded, but for various reasons most analysts and dealers prefer to work with a zero-coupon yield curve extracted from the prices of the coupon bonds. The methods discussed in the chapter are bootstrapping, cubic splines, and the Nelson–Siegel parameterization.