A General Stochastic Volatility Model for the Pricing and Forecasting of Interest Rate Derivatives
AbstractWe develop a tractable and flexible stochastic volatility multi-factor model of the term structure of interest rates. It features correlations between innovations to forward rates and volatilities, quasi-analytical prices of zero-coupon bond options and dynamics of the forward rate curve, under both the actual and risk-neutral measure, in terms of a finite-dimensional affine state vector. The model has a very good fit to an extensive panel data set of interest rates, swaptions and caps. In particular, the model matches the implied cap skews and the dynamics of implied volatilities. The model also performs well in forecasting interest rates and derivatives.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12337.
Date of creation: Jun 2006
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Publication status: published as Anders B. Trolle & Eduardo S. Schwartz, 2009. "A General Stochastic Volatility Model for the Pricing of Interest Rate Derivatives," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 22(5), pages 2007-2057, May.
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Find related papers by JEL classification:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-07-09 (All new papers)
- NEP-ECM-2006-07-09 (Econometrics)
- NEP-ETS-2006-07-09 (Econometric Time Series)
- NEP-FIN-2006-07-09 (Finance)
- NEP-FMK-2006-07-09 (Financial Markets)
- NEP-FOR-2006-07-09 (Forecasting)
- NEP-MAC-2006-07-09 (Macroeconomics)
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