Modelling Bond Yield and Forward Rate Curves for the Financial Times Actuaries British Government Securities Yield Indices

This paper discusses the existing approach to gilt yield curves used by the Financial Times and suggested by Dobbie and Wilkie This ap proach splits bonds into high medium and low coupon bands and ts separate yield curves to each In recent years this method has been identi ed as sus ceptible to catastrophic jumps when the least squares t jumps from one set of parameters to another set of quite di erent values This problem is a result of non linearities in the least squares formula which give rise to more than one local minimum A desire to remove the risk of catastrophic changes prompted this research which is being carried out as part of the work of the Fixed Interest Indices Working Party Recent data has been analysed and it is demonstrated that catastrophic jumps could occur more frequently than originally thought A new approach suggested is the use of forward rate curves rather than yield curves Recent changes to the taxation of bonds means that the same forward rate curve can be applied to both capital and income The proposed curves ap pears to provide a signi cantly better t than the present yield curve formula It is also thought that the risk of catastrophic jumps has been signi cantly reduced