Yield Curve Fitting with Artificial Intelligence: A Comparison of Standard Fitting Methods with Artificial Intelligence Algorithms

Abstract

The yield curve is a fundamental input parameter of valuation theories in capital markets. Information about yields can be observed in a discrete form, either directly through traded yield instruments (eg., interest rate swaps) or indirectly through the prices of bonds (eg., government bonds). Capital markets usually create benchmark yield curves for specific and very liquid market instruments, or for issuers where many different quotes of individual yield information for specific maturities are observable. The standard methods to construct a continuous yield curve from discrete observable yield data quotes are the fit of a mathematical model function, interpolation or regression algorithms. This paper expands these standard methods to include artificial intelligence algorithms, which have the advantage of avoiding any assumptions with regard to the mathematical model functions of the yield curve, and which can conceptually adapt easily to any market changes. Nowadays, the most widely used risk-free yield curve in capital markets is the overnight index swap (OIS) curve, which is derived from observable OISs and is used in this paper as the benchmark curve to derive and compare different yield curve fits.