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An Alternative Interest Rate Term Structure Model

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  • ECKHARD PLATEN

    (University of Technology Sydney, School of Finance & Economics and Department of Mathematical Sciences, PO Box 123, Broadway, NSW, 2007, Australia)

Abstract

This paper proposes an alternative approach to the modeling of the interest rate term structure. It suggests that the total market price for risk is an important factor that has to be modeled carefully. The growth optimal portfolio, which is characterized by this factor, is used as reference unit or benchmark for obtaining a consistent price system. Benchmarked derivative prices are taken as conditional expectations of future benchmarked prices under the real world probability measure. The inverse of the squared total market price for risk is modeled as a square root process and shown to influence the medium and long term forward rates. With constant parameters and constant short rate the model already generates a hump shaped mean for the forward rate curve and other empirical features typically observed.

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Bibliographic Info

Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

Volume (Year): 08 (2005)
Issue (Month): 06 ()
Pages: 717-735

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Handle: RePEc:wsi:ijtafx:v:08:y:2005:i:06:p:717-735

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Related research

Keywords: Interest rate term structure; growth optimal portfolio; fair pricing; market price for risk; square root process;

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Cited by:
  1. Shane Miller & Eckhard Platen, 2008. "Analytic Pricing of Contingent Claims Under the Real-World Measure," Research Paper Series 216, Quantitative Finance Research Centre, University of Technology, Sydney.
  2. Hardy Hulley & Shane Miller & Eckhard Platen, 2005. "Benchmarking and Fair Pricing Applied to Two Market Models," Research Paper Series 155, Quantitative Finance Research Centre, University of Technology, Sydney.
  3. Shane Miller & Eckhard Platen, 2004. "Two-Factor Model for Low Interest Rate Regimes," Research Paper Series 130, Quantitative Finance Research Centre, University of Technology, Sydney.
  4. Nicola Bruti-Liberati & Christina Nikitopoulos-Sklibosios & Eckhard Platen & Erik Schlogl, 2009. "Alternative Defaultable Term Structure Models," Research Paper Series 242, Quantitative Finance Research Centre, University of Technology, Sydney.
  5. El Qalli Yassine, 2009. "Term Structure Equations Under Benchmark Framework," EERI Research Paper Series EERI_RP_2009_13, Economics and Econometrics Research Institute (EERI), Brussels.

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