Term Structures
Overview
A term structure model is a model that allows you price various fixed instrument contracts. Typically
this means a curve, but the davinci quantlib wrapper includes models that price
fixed income optionality as a term structure model as well.
In order to price the contract, the projected cash flows need to be
discounted
using a
discount curve. The curve used should reflect
the riskiness of the cash flows. That is, if the bond has been issued by an entity that has some risk of default
(see
credit risk), then a curve that prices in the credit risk should be used
when discounting the cash flows.
Types
- Bootstrap
- bootstrap models take the yields for an instrument at different tenors, and constructs a curve from
those yields.
- Nelson Siegel
Option Models
Option models allow you to price options that are embedded within a fixed income contract. The most
common type of model is the short rate model, using a tree structure.