Pricing Bonds in the Australian Market is an article, which appeared in the 33rd Australian Journal of Management in 2008. Written by Bilson et al., the article does an incredible job in highlighting issues pertaining to the modeling of the term structure of interest rates. The article begins by appreciating the fact that there are various models associated with the yield curve. The authors highlight the significance of the term structure of interest rates by offering valid examples. For instance, the article points out that the yield curve plays a critical role in the valuation of a coupon bond (Christopher M. Bilson 2008). According to the authors, this demands that a coupon bond is reduced to individual cash flows valued as zero-coupon bonds
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It also reflects the market participants’ assessment of various monetary policy conditions (Rogers 1995). Theoretically, an efficient market implies that various irregularities in the yield curve can be efficiently priced out by arbitrageurs thereby leading to significant predictability within the term structure (Christopher M. Bilson 2008). However, the nature of financial markets makes it quite difficult to identify an observable continuous term structure in reality. One of the basic uses of the term structure entails the valuation of a coupon bond (Christopher M. Bilson 2008). In this case, a coupon bond is reduced into individual cash flows valued as zero coupon bonds. However, coupon bonds are incapable of fully substituting of the term structure. Therefore, modeling the term structure of interest rates is crucial when it comes to comprehending the overall credit market scenario in any given …show more content…
This is mainly because the comparative analysis of the various models of estimating the yield curve remains largely untested in the country (Rogers 1995). Intriguingly, the bulk of Australian research has historically paid immense attention to the time-series of the short end of the yield curve (Rogers 1995). Majority of Australian studies follow the precedent set by tests of the Expectation Theory, which was mainly focused on the short end of the yield curve. Furthermore, the forecasting capabilities of Australian short rate models are considerably minimal. It is extremely clear that one-factor models cannot comprehensively account for the yield curve. Therefore, Australia’s evident focus on the short rate is a key limitation when it comes to comprehending the country’s term structure of interest
It also reflects the market participants’ assessment of various monetary policy conditions (Rogers 1995). Theoretically, an efficient market implies that various irregularities in the yield curve can be efficiently priced out by arbitrageurs thereby leading to significant predictability within the term structure (Christopher M. Bilson 2008). However, the nature of financial markets makes it quite difficult to identify an observable continuous term structure in reality. One of the basic uses of the term structure entails the valuation of a coupon bond (Christopher M. Bilson 2008). In this case, a coupon bond is reduced into individual cash flows valued as zero coupon bonds. However, coupon bonds are incapable of fully substituting of the term structure. Therefore, modeling the term structure of interest rates is crucial when it comes to comprehending the overall credit market scenario in any given …show more content…
This is mainly because the comparative analysis of the various models of estimating the yield curve remains largely untested in the country (Rogers 1995). Intriguingly, the bulk of Australian research has historically paid immense attention to the time-series of the short end of the yield curve (Rogers 1995). Majority of Australian studies follow the precedent set by tests of the Expectation Theory, which was mainly focused on the short end of the yield curve. Furthermore, the forecasting capabilities of Australian short rate models are considerably minimal. It is extremely clear that one-factor models cannot comprehensively account for the yield curve. Therefore, Australia’s evident focus on the short rate is a key limitation when it comes to comprehending the country’s term structure of interest