Yield Curve Arbitrage in EUR Swap Rates: A Hybrid Neural Network Approach

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Volume Title

School of Business | Master's thesis

Date

2020

Major/Subject

Mcode

Degree programme

Finance

Language

en

Pages

61

Series

Abstract

In this thesis, I analyze the out-of-sample trading performance of a yield curve arbitrage strategy on EUR swap rates. For the implementation of the strategy, I introduce a novel hybrid neural network approach which uses the factors of an affine term structure model as inputs. I compare the results to the performance of a benchmark strategy that is based on the traditional two-factor Vasicek term structure model. The results imply that with reasonable transaction costs, the neural network model produces significant multifactor alpha, positively skewed returns with high kurtosis and a higher Sharpe ratio and higher absolute cumulative performance compared to the Vasicek model. However, the neural network strategy also has exposure to systematic risk factors and tail risk.

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Thesis advisor

Suominen, Matti

Keywords

yield curve, machine learning, neural network, interest rate, arbitrage

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