Modeling the Term Structure of Interest Rates with General Diffusion Processes: A Moment Approximation Approach
AbstractWe propose an analytical approximation of the term structure of interest rates under general diffusion processes of the short-rate and state variables. A method of approximating conditional moments as the solution to a system of ordinary differential equations is applied to the pricing of bonds. Numerical experiments based on two illustrative models show that the second-order approximation is accurate for maturities of up to five years and the third-order approximation is effective for longer maturities. We also show the possibility of improving the second-order approximation without much increasing the computational burden.
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Bibliographic InfoPaper provided by Graduate School of Economics, Hitotsubashi University in its series Discussion Papers with number 2006-05.
Length: 17,  p.
Date of creation: Oct 2007
Date of revision:
Short-rate; Term structure; Approximation; Conditional moment;
Other versions of this item:
- Takamizawa, Hideyuki & Shoji, Isao, 2009. "Modeling the term structure of interest rates with general diffusion processes: A moment approximation approach," Journal of Economic Dynamics and Control, Elsevier, vol. 33(1), pages 65-77, January.
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
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