eprintid: 190
rev_number: 4
eprint_status: archive
userid: 6
dir: disk0/00/00/01/90
datestamp: 2008-10-31
lastmod: 2015-05-29 19:49:02
status_changed: 2009-04-08 16:55:38
type: report
metadata_visibility: show
item_issues_count: 0
creators_name: Lee, Seung Youn
contributors_name: Kletskin, Ilona
contributors_name: Li, Hua
contributors_name: Li, Mingfei
contributors_name: Liu, Rongsong
contributors_name: Tolmasky, Carlos
contributors_name: Wu, Yujun
title: Correlation Structures Corresponding to Forward Rates
ispublished: pub
subjects: finance
studygroups: ipsw7
companyname: Cargill Incorporation
full_text_status: public
abstract: In finance, there is a constant effort to model future prices of stocks, bonds, and commodities; the ability to predict future behaviour provides important information about the underlying structure of these securities. While it has become common to model a single stock using the Black-Scholes formulation, the modelling of bond prices requires one to simulate the change of interest rates as a function of their maturity, which requires one to model the movement of an entire yield curve. If one studies the spectral decomposition of the correlation matrix corresponding to the spot rates from this curve, then one finds that the top three components can explain nearly all of the data; in addition, this same structure is observed for any bond or commodity. In his 2000 paper, Ilias Lekkos [4] proposes that such results are an artefact due to the implicit correlation between spot rates, and that the analysis should instead be performed using forward rates. In this paper, we discuss the results obtained for the spectral structure of the correlation matrices of forward rates, and investigate a model for this associated structure. The paper is divided into four parts, covering forward rates background material, principal components analysis, yield curve modelling, and conclusions and research extensions.
problem_statement: In finance, it is common to model a single stock using the Black-Scholes formulation. However, the modelling of bond prices requires one to simulate the change of interest rates as a function of their maturity, which requires one to model the movement of an entire yield curve. We would therefore like to investigate how to model this appropriately.
date: 2003
date_type: published
pages: 9
referencetext: [4] I. Lekkos, A Critique of Factor Analysis of Interest Rates, Journal of Derivatives, Fall 2000, pp. 72–83.
citation:   Lee, Seung Youn  (2003) Correlation Structures Corresponding to Forward Rates.  [Study Group Report]     
document_url: http://miis.maths.ox.ac.uk/miis/190/1/cargill.pdf