A Unified Approach to Term Structure Estimation: A Methodology for Estimating the Term Structure in a Market with Frictions

Abstract

This paper develops a methodology for term structure estimation from a no-arbitrage condition in markets with frictions. The methodology unifies existing estimation procedures, such as the regression and linear programming approaches, and substantially broadens the class of useful estimation techniques. The estimators derived in this way are capable of reflecting actual market conditions, such as the asymmetry in the tax treatment of long and short positions and the higher financial cost of establishing a short position. The methodology is derived by applying the conjugate duality theory of mathematical programming.