On the range of admissible term-structures

In this paper, we analyze the diversity of term structure functions (e.g., yield curves, swap curves, credit curves) constructed in a process which complies with some admissible properties: arbitrage-freeness, ability to fit market quotes and a certain degree of smooth- ness. When present values of building instruments are expressed as linear combinations of some primary quantities such as zero-coupon bonds, discount factor, or survival probabilit- ies, arbitrage-free bounds can be derived for those quantities at the most liquid maturities. As a matter of example, we present an iterative procedure that allows to compute model-free bounds for OIS-implied discount rates and CDS-implied default probabilities. We then show how mean-reverting term structure models can be used as generators of admissible curves. This framework is based on a particular specification of the mean-reverting level which al- lows to perfectly reproduce market quotes of standard vanilla interest-rate and default-risky securities while preserving a certain degree of smoothness. The numerical results suggest that, for both OIS discounting curves and CDS credit curves, the operational task of term- structure construction may be associated with a significant degree of uncertainty.

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