The MIIS Eprints Archive

Correlation Structures Corresponding to Forward Rates

Lee, Seung Youn (2003) Correlation Structures Corresponding to Forward Rates. [Study Group Report]



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.

Item Type:Study Group Report
Problem Sectors:Finance
Study Groups:Canadian Industrial Problem Solving Workshops > IPSW 7 (Calgary, Canada, May 25-29, 2003)
Company Name:Cargill Incorporation
ID Code:190
Deposited By: Michele Taroni
Deposited On:31 Oct 2008
Last Modified:29 May 2015 19:49

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