Choosing Short-End Inputs for Non-Core Eurozone Sovereign Curves
Summary
The document considers which market data should anchor the short end of zero-coupon curves for Eurozone sovereign issuers outside Germany. It distinguishes interbank reference rates such as Euribor and EONIA from government borrowing rates: the former reflect lending among highly rated contributor banks and therefore do not represent the credit risk of a peripheral sovereign. Using those rates directly for a sovereign discount curve can mismatch the issuer risk being modeled.
The response notes that curve construction may be constrained when short-dated government securities are unavailable. In that case, a constant forward rate can be extended to the first available market observation. It also cautions that including every short-term government security may not suit every application, since parametric fitting can behave poorly and observed spreads against other short rates may be unstable. The document gives conceptual guidance, not a country-specific instrument set or detailed bootstrapping procedure; curve choices depend on available securities and intended use.
Key ideas
- Euribor and EONIA represent interbank credit exposure rather than peripheral sovereign credit risk.
- A sovereign discount curve should use inputs whose risk corresponds to the issuer being valued.
- When short-term government securities are unavailable, a constant forward rate may be extended to the first observed point.
- Short-dated securities and spreads may be unstable or distort a parametric curve fit, depending on the application.
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Full text
# How to build the short end of a zero coupon curve for non-core Eurozone countries? # How to build the short end of a zero coupon curve for non-core Eurozone countries? I am in the process of building zero coupon curves for some countries in the Eurozone. I have the following data sets: - Euribor and EONIA - Swap rates - Bond price and yields The bond prices (and thus yields) reflect the relative credit worthiness of the sovereign issuer (a point that has come to the fore most recently). For the longer dated time buckets therefore, the yields "make sense". At the shorter end however, the official rates seems to be Euribor and EONIA (for s/n-o/n) - I can't see how this makes sense - since these are the same data points I would be using to evaluate "high quality" debt from Germany (for example). I can't see how it makes sense to use these same points for constructing yield curves for any of the peripheral Euro-zone countries - as the credit risk does not seem to be reflected at the short end - am I missing something? What data points do professionals out there use to construct yield curves for Eurozone countries (with the exception of Germany)? ## Answer by Erik Olson (score 4) https://quant.stackexchange.com/a/2039 The risk implied by Euribor or EONIA (or their swaps) is for lending to another prime rated bank. These rate indexes represent where contributor banks are offering funds to each other in the interbank market. Contributing banks are mostly rated P-1 (Moody’s) or A-1 (S&P). You wouldn’t use these rates for govt discount curves because the risk doesn’t match. If there are no short term govt securities you would have only a constant forward rate up to the first data point. Even when there are short term securities, you don’t necessarily want them in every application. A parametric curve fitting might do a poor job with them. Spreads between short term govt and other short term rates might be ill-behaved.
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