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A yield-factor model of interest rates. (English) Zbl 0915.90014

Summary: This paper presents a consistent and arbitrage-free multifactor model of the term structure of interest rates in which yields at selected fixed maturities follow a parametric multivariate Markov diffusion process with “stochastic volatility”. The yield of any zero-coupon bond is taken to be a maturity-dependent affine combination of the selected “basis” set of yields. We provide necessary and sufficient conditions on the stochastic model for this affine representation. We include numerical techniques for solving the model, as well as numerical techniques for calculating the prices of term-structure derivative prices. The case of jump diffusions is also considered.

MSC:

91G30 Interest rates, asset pricing, etc. (stochastic models)
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References:

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