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Markov-functional interest rate models

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Author Info

  • Joanne Kennedy

    ()
    (Department of Statistics, University of Warwick, Coventry CV4 7AL, United Kingdom)

  • Phil Hunt

    ()
    (Global Derivatives and Fixed Income Markets, Westdeutsche Landesbank Girozentrale, 33/36 Gracechurch Street, London EC3V 0AX, United Kingdom)

  • Antoon Pelsser

    ()
    (Structured Products Group , ABN-Amro Bank, P.O. Box 283, 1000 EA Amsterdam, The Netherlands and Department of Finance, Erasmus University Rotterdam, P.O. Box 1738, 3000 DR Rotterdam, The Netherlands Manuscript)

Abstract

We introduce a general class of interest rate models in which the value of pure discount bonds can be expressed as a functional of some (low-dimensional) Markov process. At the abstract level this class includes all current models of practical importance. By specifying these models in Markov-functional form, we obtain a specification which is efficient to implement. An additional advantage of Markov-functional models is the fact that the specification of the model can be such that the forward rate distribution implied by market option prices can be fitted exactly, which makes these models particularly suited for derivatives pricing. We give examples of Markov-functional models that are fitted to market prices of caps/floors and swaptions.

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File URL: http://link.springer.de/link/service/journals/00780/papers/0004004/00040391.pdf
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Bibliographic Info

Article provided by Springer in its journal Finance and Stochastics.

Volume (Year): 4 (2000)
Issue (Month): 4 ()
Pages: 391-408

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Handle: RePEc:spr:finsto:v:4:y:2000:i:4:p:391-408

Note: received: June 1999; final version received: August 1999
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Web page: http://www.springerlink.com/content/101164/

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Related research

Keywords: Yield curve modelling; derivatives pricing; Markov processes;

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Citations

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Cited by:
  1. Jiro Akahori & Andrea Macrina, 2010. "Heat Kernel Interest Rate Models with Time-Inhomogeneous Markov Processes," Papers 1012.1878, arXiv.org.
  2. Jiro Akahori & Yuji Hishida & Josef Teichmann & Takahiro Tsuchiya, 2009. "A Heat Kernel Approach to Interest Rate Models," Papers 0910.5033, arXiv.org.
  3. Lord, Roger & Fang, Fang & Bervoets, Frank & Oosterlee, Kees, 2007. "A fast and accurate FFT-based method for pricing early-exercise options under Lévy processes," MPRA Paper 1952, University Library of Munich, Germany.
  4. Antonis Papapantoleon, 2009. "Old and new approaches to LIBOR modeling," Papers 0910.4941, arXiv.org, revised Apr 2010.
  5. Raoul Pietersz & Antoon Pelsser, 2005. "A Comparison of Single Factor Markov-functional and Multi Factor Market Models," Finance 0502008, EconWPA.
  6. Mamon, Rogemar S., 2002. "A time-varying Markov chain model of term structure," Statistics & Probability Letters, Elsevier, vol. 60(3), pages 309-312, December.
  7. Albanese, Claudio, 2007. "Callable Swaps, Snowballs And Videogames," MPRA Paper 5229, University Library of Munich, Germany, revised 01 Oct 2007.
  8. Nicola Moreni & Andrea Pallavicini, 2010. "Parsimonious HJM Modelling for Multiple Yield-Curve Dynamics," Papers 1011.0828, arXiv.org.
  9. Yuta Inoue & Takahiro Tsuchiya, 2011. "Defaultable Bonds via HKA," Papers 1103.4541, arXiv.org.
  10. Raoul Pietersz & Antoon Pelsser & Marcel van Regenmortel, 2005. "Fast drift approximated pricing in the BGM model," Finance 0502005, EconWPA.

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