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Modeling the Interest Rate Term Structure: Derivatives Contracts Dynamics and Evaluation

Author

Listed:
  • Cícero Augusto Vieira Neto

    (Bolsa de Mercadorias e de Futuros (BM&F))

  • Pedro L. Valls Pereira

    (Ibmec, SP)

Abstract

This article deals with a model for the term structure of interest rates and the valuation of derivative contracts directly dependent on it. The work is of a theoretical nature and deals, exclusively, with continuous time models, making ample use of stochastic calculus results and presents original contributions that we consider relevant to the development of the fixed income market modeling. We develop a new multifactorial model of the term structure of interest rates. The model is based on the decomposition of the yield curve into the factors level, slope, curvature, and the treatment of their collective dynamics. We show that this model may be applied to serve various objectives: analysis of bond price dynamics, valuation of derivative contracts and also market risk management and formulation of operational strategies which is presented in another article.

Suggested Citation

  • Cícero Augusto Vieira Neto & Pedro L. Valls Pereira, 2005. "Modeling the Interest Rate Term Structure: Derivatives Contracts Dynamics and Evaluation," Brazilian Review of Finance, Brazilian Society of Finance, vol. 3(1), pages 19-54.
    • Handle: RePEc:brf:journl:v:3:y:2005:i:1:p:19-54
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    More about this item

    Keywords

    term structure of interest rates; dynamics; derivatives contract pricing;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General

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