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Conditional Gaussian models of the term structure of interest rates

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  • Simon H. Babbs

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    (Bank One and University of Warwick, 1 Bank One Plaza Suite# 0690, Chicago IL 60670, USA Manuscript)

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    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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    Bibliographic 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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    Web page: http://www.springerlink.com/content/101164/

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    Related research

    Keywords: Interest rate models; market models; Conditional Gaussian;

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

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