Hybrid Yield curves modeling in WAEMU Zone

Abstract

In the WAEMU zone (West African Economic and Monetary Union.), the development of the financial market is hampered by uncertainties related to information asymmetries. In order to reduce them, this study proposes a quantitative model for evaluating the hybrid zero-coupon (ZC) yield curve, which takes into account investors’ perception of risk. This innovative approach is based on the model of the risk-free rate curve, as well as the model of decomposition of the term structure of risk premia, which results in the explicit formulation of the term structures of credit risk and liquidity premiums and the anticipated recovery rate by the financial market in the event of issuer default. Over the period 2019-2023, the empirical application reveals that the hybrid ZC yield curve is sensitive to monetary policy decisions, as well as to the parameters of the risk-free yield curve. Moreover, the term structure of the risk premiums becomes stable when it is estimated by a hybrid model, composed of three extreme probability distributions, namely the Weibull-Gumbel models for interpolation and Log-Normal for extrapolation.