Content:
All valuations (discounted cash flow, instrument pricing, option pricing) and other financial calculations require an estimate of the evolution of the risk-free rates as implied by the term and volatility structures. This presumes that one has, if not perfect knowledge, at least very good estimates of these market term structures. In this paper we review and compare the existing methodologies for deriving zero-curves (spot rates, forward rates and discount factors) and volatility estimates.
In particular, term and volatility structures are the corner stone to practically all valuations of fixed income financial instruments and consequently affects, or should affect, significantly the trading and the management of financial holdings; they are also used to help shape monetary policy by Central Banks. Part I is devoted to a review and a comparison of the methods that have been suggested to construct the term structure associated with a given collection of fixed income financial instruments. Part II addresses the problem of determining the (associated) volatility structure that has been given only scant attention in the literature.
December 08, 2004