Interpolation

Interpolation is a technique used in order to estimate the value of a point that rests between two other data points. Linear interpolation involves drawing a straight line between the two points and estimating the value at the point of interest. For example, 5 year bond yields are 1.00% and 10 year bond yields are 2.00%, what is the estimate of the 8 year yield. Using simple linear interpolation it would be a little above 1.50%. In interest rate markets where participants are dealing with curves rather than straight lines, more sophisticated techniques such as cubic splining and curve fitting are used to estimate the value at the desired point.

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