Approximating term structure of interest rates using cubic L1 splines

Classical spline fitting methods for estimating the term structure of interest rates have been criticized for generating highly fluctuating fitting curves for bond price and discount function. In addition, the performance of these methods usually relies heavily on parameter tuning involving human judgement. To overcome these drawbacks, a recently developed cubic L-1 spline model is proposed for term structure analysis. Cubic L-1 splines preserve the shape of the data, exhibit no extraneous oscillation and have small fitting errors. Cubic L-1 splines are tested using a set of real financial data and compared with the widely used B-splines. (C) 2006 Elsevier B.V. All rights reserved.