Abstract
The paper examines term structure decomposition at the instrument level – decomposing term structures for issues as well as the portfolio. Three different implementations are stipulated: axiomatic structural approaches, a sequential approach, and a base structure approach. The three different implementations are evaluated against a portfolio of risk-free government bonds. The goodness-of-fit and smoothness properties of instrument-level term structure decomposition are also considered. The conclusion points to remaining gaps in theory regarding instrument-level term structure decomposition, and considers areas of application – typically bond valuation.
Highlights
Barnard (2019) introduces and reviews term structure decomposition, its purpose and objective, the applicable models used to decompose term structures, and offers a brief comparison of these – their performance, strengths and weaknesses. Barnard (2019) introduces an axiomatic structural approach as term structure decomposition method
It allows individual issue term structures to naturally deviate from the portfolio term structure, as it accommodates the unsystematic risk components of issues
The problem with the optimization problem of equation set 2 is that, it defines the relationship between issue and portfolio term structures, and it permits issue and portfolio term structures to be decomposed, the resultant structures would generally have poor smoothness, as little is stipulated in this regard
Summary
Barnard (2019) introduces and reviews term structure decomposition, its purpose and objective, the applicable models used to decompose term structures, and offers a brief comparison of these – their performance, strengths and weaknesses. Barnard (2019) introduces an axiomatic structural approach as term structure decomposition method. Barnard (2019) introduces and reviews term structure decomposition, its purpose and objective, the applicable models used to decompose term structures, and offers a brief comparison of these – their performance, strengths and weaknesses. Barnard (2019) introduces an axiomatic structural approach as term structure decomposition method. The premises of term structure decomposition at the instrument level are introduced. Term structure decomposition at the istrument level is the focus of this study.
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