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A tractable market model with jumps for pricing short-term interest rate derivatives

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  • Y. Samuelides
  • E. Nahum
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    Abstract

    Short-term interest rate derivatives present a few unresolved problems. It is not obvious which pricing model to use, and the usual Heath-Jarrow-Morton type models seem insufficient to describe the risk they entail. Moreover, the hedging process is fairly delicate as the liquidity of short-term products cannot always be relied upon. In this paper, we justify the use of a market model with jumps to price these products. The main advantage of this approach is two fold. First, we will show how realistic such a model proves to be. Then, using justified approximations, the market model with jumps is made very tractable. Finally, the hedging issue is resolved by describing a dynamic delta-hedging strategy provided by the model in addition to a static vega-hedging strategy designed to use the relevant liquid products at the trader's disposal.

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    File URL: http://www.tandfonline.com/doi/abs/10.1088/1469-7688/1/2/309
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Quantitative Finance.

    Volume (Year): 1 (2001)
    Issue (Month): 2 ()
    Pages: 270-283

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    Handle: RePEc:taf:quantf:v:1:y:2001:i:2:p:270-283

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    Cited by:
    1. Nicola Bruti-Liberati, 2007. "Numerical Solution of Stochastic Differential Equations with Jumps in Finance," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 1.
    2. Nicola Bruti-Liberati & Eckhard Platen, 2006. "On Weak Predictor-Corrector Schemes for Jump-Diffusion Processes in Finance," Research Paper Series 179, Quantitative Finance Research Centre, University of Technology, Sydney.

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