Pricing bonds in the Australian market

This paper provides an examination of term structure models in the Australian bond market. Specifically, we examine the comparative ability of various models to forecast at the short, medium and long ends of the yield curve. Overall, we find that model performance varies along the yield curve. Out-of-sample pricing tests show that most of the term structure models underprice a bond at the short and medium ends of the term structure and generally overprice bonds at the long end. Further, the level of mispricing is related to time-to-maturity, coupon payments and interest rate volatility. The results have implications for bond pricing in relatively illiquid markets like Australia's.