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Term Structure Equations Under Benchmark Framework

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  • El Qalli Yassine

Abstract

This paper makes use of an integrated benchmark modeling framework that allows us to derive term structure equations for bond and forward prices. The benchmark or numeraire is chosen to be the growth optimal portfolio (GOP). For deterministic short rate the solution of the bond term structure equation coincides with the explicit formula obtained in Platen(2005). The resulting term structure equations are used to explain moves in bond and forward prices by introducing GOP as a factor and therefore constructing a hedge portfolio for bond consisting of units of the GOP and the saving account. The paper also derives an affine term structure equation for forward price in term of the GOP factor. In the case of stochastic short rate we restrict our selves to give only a term structure equation for the bond price.

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File URL: http://www.eeri.eu/documents/wp/EERI_RP_2009_13.pdf
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Bibliographic Info

Paper provided by Economics and Econometrics Research Institute (EERI), Brussels in its series EERI Research Paper Series with number EERI_RP_2009_13.

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Length: 23 pages
Date of creation: 08 2009
Date of revision:
Handle: RePEc:eei:rpaper:eeri_rp_2009_13

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Keywords: Term structure; Benchmark approach; GOP; Forward price; bond.;

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  1. Eckhard Platen, 2005. "An Alternative Interest Rate Term Structure Model," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 8(06), pages 717-735.
  2. Eckhard Platen, 2001. "Arbitrage in Continuous Complete Markets," Research Paper Series 72, Quantitative Finance Research Centre, University of Technology, Sydney.
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