How Well Do Constant-Maturity Treasuries Approximate the On-the-Run Term Structure

01 September 2000
By Dr. James Jordan with Financial Markets Institute and Duquesne University Donahue School of Business Assistant Professor of Finance Sattar Mansi

The authors compare the use of constant-maturity Treasuries as an alternative to on-the-run yields obtained from the Treasury market, looking at pricing errors in the period January 1, 1990, through December 31, 1997. For pricing, they use bootstrapping based on discrete time and continuous time with two functional forms: the cubic spline functional form based on the van Deventer and Imai (1996) specification and the Nelson and Siegel (1987) functional form. They include bootstrapping based on the cubic spline functional form for comparative purposes, because it is one method the Treasury uses in its estimation of constant-maturity series.

The article's main finding is that the Treasury Department can dramatically improve its estimation of constant-maturity series by adopting a different methodology from the one it now uses. According to our results, a continuous bootstrapping methodology with the Nelson and Siegel functional form as the interpolation method can reduce pricing errors dramatically. This certainly has implications for both academicians and practitioners who widely use constant-maturity Treasuries as a surrogate for on-the-run Treasuries.

This article was published in The Journal of Fixed Income, Vol. 10, No. 3, Fall 2000.