Interest rate risk measurement in Brazilian sovereign markets

Abstract

Fixed income emerging markets are an interesting investment alternative. Measuring market risks is mandatory in order to avoid unexpected huge losses. The most used market risk measure is the Value at Risk, based on the profit-loss probability distribution of the portfolio under consideration. Estimating this probability distribution requires the prior estimation of the probability distribution of term structures of interest rates. An interesting possibility is to estimate term structures using a decomposition of the spread function into a linear combination of Legendre polynomials. Numerical examples from the Brazilian sovereign fixed income international market illustrate the practical use of the methodology.