Improving the Quality of the Input in the Term Structure Consistent Models

In finance, getting an accurate estimation of the term structure of interest rates is essential because this information is often used as input by other pricing financial models. In this paper, we point out the importance of selecting a suitable estimation of the term structure of interest rates. To show this fact, we use the Spanish Bond Market to estimate the initial interest rate and forward curves for one day, by using both McCulloch (1975) cubic polynomial splines, and Legendre's polynomials (Morini, 1998). We use these curves as input for pricing pure discount bonds with the Ho and Lee (1986) and Hull and White (1990) models. Then, we find the important result that using an inadequate interest rate curve affects dramatically the behaviour of the dynamic term structure models and, consequently, the estimation of the asset pricing models