Yield curve estimation: Theory and application for Turkish market

The scope of this work is to discuss yield curve theories, explain the use of yield curves and estimate yield curve for zero-coupon bonds. In our study, the yield curve theories that we express here are Market Expectations Theory, Liquidity Premium Theory, Market Segmentation Theory and Preferred Habitat Theory. The concepts like Expectations, Risk Premium and Convexity which determine shape of the curves are also explained in this project.In our empirical work, we used four different types of yield curve estimation method to express zero-coupon bond yield curve for dates from January 3rd , 2006 to May 2nd, 2008. We collect data from Istanbul Stock Exchange daily bulletins in order to have a homogenous data set by using specific filter criteria used. Nelson-Siegel , Svensson, Cubic Spline and Smoothing Cubic Spline Methods are practiced by using Matlab program. To estimate Nelson-Siegel and Svensson Method?s parameters we ran constrained nonlinear least square optimization procedure.In order to compare methods performance we calculated Root Mean Square Error, Mean Absolute Error, Weighted Mean Absolute Error terms for in sample forecast and out of sample forecasts. As a result of the comparison process the best performed method is Smoothing Cubic Spline either in sample or out of sample forecasts. In parametric methods Svensson Method gave a better result than Nelson-Siegel.