Term Structure Estimation

Abstract

The term structure of interest rates gives the relationship between the yield on an investment and the term to maturity of the investment. Since the term structure is typically measured using default-free, continuously-compounded, annualized zero-coupon yields, it is not directly observable from the published coupon bond prices and yields. This paper focuses on how to estimate the default-free term structure of interest rates from bond data using three methods: the bootstrapping method, the McCulloch cubic-spline method, and the Nelson and Siegel method. Nelson and Siegel method is shown to be more robust than the other two methods. The results of this paper can be implemented using user-friendly Excel spreadsheets.