Mastering Interest Rate Curve Construction in the Australian Market

Building an accurate and robust interest rate curve has significant implications for setting benchmark rates to managing risk.

The Australian interest rate market has a number of unique characteristics that set it apart from other global interest rate markets. Thesecharacteristics require specialised techniques and a deep understanding when it comes to accurate curve construction, pricing, and risk management.

Building a robust and accurate interest rate curve relies on the use of liquid market instruments. These instruments, such as interest rate swaps and futures, or government bonds, provide insight into the market consensus about future interest rates. Identifying and using these instruments is crucial as it enables accurate pricing and a timely response to market changes.

The construction of interdependent or “entangled” curves represents a challenge in quantitative finance due to their inherent complexity. The requirement for a multi-dimensional optimiser, which can often be slow or unstable, has prompted researchers and practitioners to explore alternative methods. These approaches aim to sidestep the need for a true global optimiser, whilst still providing accurate and reliable results.

Contents

  • Single Curve Bootstrap Versus Global Optimisation
  • Entangled Curves
  • Special Features of the Australian Interest Rate Market
    • Multiple Active Benchmarks
    • Unique Market Instruments
    • Unique Combination of Liquid Instruments
    • Interdependencies in Curve Construction
    • RBA’s Role in Market Stability
  • A Comprehensive Solution for Interest Rate Curve Construction

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