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Nonparametric Pricing of Interest Rate Derivative Securities

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  • Yacine Ait-Sahalia

Abstract

We propose a nonparametric estimation procedure for continuous- time stochastic models. Because prices of derivative securities depend crucially on the form of the instantaneous volatility of the underlying process, we leave the volatility function unrestricted and estimate it nonparametrically. Only discrete data are used but the estimation procedure still does not rely on replacing the continuous- time model by some discrete approximation. Instead the drift and volatility functions are forced to match the densities of the process. We estimate the stochastic differential equation followed by the short term interest rate and compute nonparametric prices for bonds and bond options.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5345.

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Date of creation: Nov 1995
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Publication status: published as Econometrica, May 1996, vol.64, no.3, pp.527-560.
Handle: RePEc:nbr:nberwo:5345

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  1. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, Elsevier, vol. 5(2), pages 177-188, November.
  2. Pearson, Neil D & Sun, Tong-Sheng, 1994. " Exploiting the Conditional Density in Estimating the Term Structure: An Application to the Cox, Ingersoll, and Ross Model," Journal of Finance, American Finance Association, American Finance Association, vol. 49(4), pages 1279-1304, September.
  3. Brennan, Michael J. & Schwartz, Eduardo S., 1979. "A continuous time approach to the pricing of bonds," Journal of Banking & Finance, Elsevier, Elsevier, vol. 3(2), pages 133-155, July.
  4. Peter C.B. Phillips, 1985. "Time Series Regression with a Unit Root," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 740R, Cowles Foundation for Research in Economics, Yale University, revised Feb 1986.
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  6. Gourieroux, C. & Monfort, A. & Renault, E., 1992. "Indirect Inference," Papers, Toulouse - GREMAQ 92.279, Toulouse - GREMAQ.
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  8. Nelson, Daniel B., 1990. "ARCH models as diffusion approximations," Journal of Econometrics, Elsevier, Elsevier, vol. 45(1-2), pages 7-38.
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  13. Brown, Stephen J & Dybvig, Philip H, 1986. " The Empirical Implications of the Cox, Ingersoll, Ross Theory of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 41(3), pages 617-30, July.
  14. Constantinides, George M, 1992. "A Theory of the Nominal Term Structure of Interest Rates," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 5(4), pages 531-52.
  15. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1980. " An Analysis of Variable Rate Loan Contracts," Journal of Finance, American Finance Association, American Finance Association, vol. 35(2), pages 389-403, May.
  16. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  17. Chan, K C, et al, 1992. " An Empirical Comparison of Alternative Models of the Short-Term Interest Rate," Journal of Finance, American Finance Association, American Finance Association, vol. 47(3), pages 1209-27, July.
  18. Duffie, Darrell & Singleton, Kenneth J, 1993. "Simulated Moments Estimation of Markov Models of Asset Prices," Econometrica, Econometric Society, Econometric Society, vol. 61(4), pages 929-52, July.
  19. Courtadon, Georges, 1982. "The Pricing of Options on Default-Free Bonds," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 17(01), pages 75-100, March.
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