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Numerical Methods and Optimization in Finance by Enrico Schumann, Dietmar Maringer, Manfred Gilli

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Chapter Fourteen

Econometric Models

Publisher Summary

Whenever one reads about the yield curve or the term structure of interest rates, chances are that there is a diagram that shows the interest rate as a smooth function of time. Such a function is actually not observable; it must be estimated or constructed somehow from what is available: deposits, coupon bonds, swaps, and a vast number of other interest rate products. Sometimes these products are quoted in terms of price, like a bond, or in terms of an interest rate, like a deposit. The existence of such a smooth curve can be justified by arbitrage. If there were two products with similar properties like default risk or liquidity, but different prices (which are functions of the interest rate), ...

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