Bootstrapping the Illiquidity: Multiple Yield Curves Construction for Market Coherent Forward Rates Estimation
A version of this paper was published as chapter 1 in "Modeling Interest Rates", edited by Fabio Mercurio, Risk Books, 1 May 2009, ISBN 9781906348137
Posted: 2 Apr 2009 Last revised: 10 Sep 2018
Date Written: May 1, 2009
The large basis spreads observed on the interest rate market since the liquidity crisis of summer 2007 imply that different yield curves are required for market coherent estimation of forward rates with different tenors (e.g. Euribor 3 months, Euribor 6 months, etc.).
In this paper we review the methodology for bootstrapping multiple interest rate yield curves, each homogeneous in the underlying rate tenor, from non-homogeneous plain vanilla instruments quoted on the market, such as Deposits, Forward Rate Agreements, Futures, Swaps, and Basis Swaps.
The approach includes turn of year effects and is robust to deliver smooth yield curves and to ensure non-negative rates also in highly stressed market situations, characterized by crazy roller coaster shapes of the market quotations.
The concrete EUR market case is analyzed in detail, using the open source QuantLib implementation of the proposed algorithms.
Keywords: Liquidity crisis, credit crunch, interest rates, yield curve, forward curve, discount curve, bootstrapping, pricing, hedging, interest rate derivatives, Deposit, FRA, Futures, Swap, Basis Swap, turn of year, spline, QuantLib
JEL Classification: E45, G13
Suggested Citation: Suggested Citation