BFS 2002

Contributed Talk

Initial Curves for Interest Rate Models: the Importance of Consistency

Stefano Herzel, Flavio Angelini

We study the practical implications of imposing "consistency" on the choice of the initial curve on the calibration of an HJM model. Consistency, simply stated, is that the initial curve should come from the class of forward rate curves that will be generated by the model at futures dates. We perform analysis both on simulated and market data using the extended Vasicek model. Our results show that the initial curve has a significative impact on the estimates of the parameter of the model. We identify a family, consistent with the model, which, on market data, shows more stable estimates, as well as better fitting and forecasting capabilities.