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Conditional Gaussian models of the term structure of interest rates

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Author Info
Simon H. Babbs () (Bank One and University of Warwick, 1 Bank One Plaza Suite# 0690, Chicago IL 60670, USA Manuscript)
Abstract

We present a new family of yield curve models, termed "Conditional Gaussian". It provides both simplicity and extreme flexibility in constructing "market models". Almost any conditional co-variance structure - including features designed to capture volatility "skews" and/or dependence on past returns - can be used, and the model can be embedded into a continuous-time whole yield curve model consistent with general equilibrium. Conditionally Gaussian increments in log one-plus-interest-rates enable "vanilla" and path-dependent derivatives to be valued easily by Monte Carlo, whether or not their payoffs depend solely on the particular market rates being modelled directly.

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Publisher Info
Article provided by Springer in its journal Finance and Stochastics.

Volume (Year): 6 (2002)
Issue (Month): 3 ()
Pages: 333-353
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Handle: RePEc:spr:finsto:v:6:y:2002:i:3:p:333-353

Note: received: June 1999; final version received: September 2001
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Related research
Keywords: Interest rate models market models Conditional Gaussian

Find related papers by JEL classification:
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

Cited by:
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  1. Serafín Frache & Gabriel Katz, 2004. "Estimating a Risky Term Structure of Uruguayan Sovereign Bonds," Documentos de Trabajo (working papers) 0304, Department of Economics - dECON. [Downloadable!]
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