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Fundamental Properties of Bond Prices in Models of the Short-Term Rate

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Author Info
Antonio Mele

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Abstract

This article develops restrictions that arbitrage-constrained bond prices impose on the short-term rate process in order to be consistent with given dynamic properties of the term structure of interest rates. The central focus is the relationship between bond prices and the short-term rate volatility. In both scalar and multidimensional diffusion settings, typical relationships between bond prices and volatility are generated by joint restrictions on the risk-neutralized drift functions of the state variables and convexity of bond prices with respect to the short-term rate. The theory is illustrated by several examples and is partially extended to accommodate the occurrence of jumps and default. Copyright 2003, Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/rfs/hhg011
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Publisher Info
Article provided by Oxford University Press for Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 16 (2003)
Issue (Month): 3 (July)
Pages: 679-716
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Handle: RePEc:oup:rfinst:v:16:y:2003:i:3:p:679-716

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References listed on IDEAS
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    Other versions:
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    Other versions:
  30. Chapman, David A & Long, John B, Jr & Pearson, Neil D, 1999. "Using Proxies for the Short Rate: When Are Three Months Like an Instant?," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 12(4), pages 763-806.
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  31. Conley, Timothy G, et al, 1997. "Short-Term Interest Rates as Subordinated Diffusions," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 10(3), pages 525-77.
  32. Jagannathan, Ravi, 1984. "Call options and the risk of underlying securities," Journal of Financial Economics, Elsevier, vol. 13(3), pages 425-434, September. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Mele, Antonio, 2004. "General Properties of Rational Stock-Market Fluctuations," Economics Series 153, Institute for Advanced Studies. [Downloadable!]
    Other versions:
  2. Xavier Gabaix, 2007. "Linearity-Generating Processes: A Modelling Tool Yielding Closed Forms for Asset Prices," NBER Working Papers 13430, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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