Fitting the Term Structure of Interest Rates with Smoothing Splines

We describe a technique for fitting the term structure of interest rates using smoothing splines, which incorporate a quot;roughnessquot; penalty. An increase in the penalty reduces the effective number of parameters. We use generalized cross validation to choose adaptively the penalty and hence the effective number of parameters. We show how our technique can be used to spline an arbitrary transformation of the discount function, using a B-spline bases. Our Monte Carlo simulations and estimation results suggest that fitting a smoothing spline to the forward rate curve using generalized cross validation produces the best results