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Fundamental Properties of Bond Prices in Models of the Short-Term Rate

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  • Antonio Mele

    (Queen Mary, University of London)

Abstract

This paper develops restrictions that arbitrage-constrained bond prices impose on the short-term rate process in order to be consistent with given dynamic properties of the term-structure of interest rates. The central focus is the relationship between bond prices and the short-term rate volatility. In both scalar and multidimensional diffusion settings, typical relationships between bond prices and volatility are generated by joint restrictions on the risk-neutralized drift functions of the state variables and convexity of bond prices with respect to the short-term rate. The theory is illustrated by several examples and is partially extended to accommodate the occurrence of jumps and default.

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Bibliographic Info

Paper provided by Queen Mary, University of London, School of Economics and Finance in its series Working Papers with number 460.

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Date of creation: Jun 2002
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Handle: RePEc:qmw:qmwecw:wp460

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Cited by:
  1. Antonio Mele, 2004. "General Properties of Rational Stock-Market Fluctuations," Econometric Society 2004 North American Summer Meetings 223, Econometric Society.
  2. Xavier Gabaix, 2007. "Linearity-Generating Processes: A Modelling Tool Yielding Closed Forms for Asset Prices," NBER Working Papers 13430, National Bureau of Economic Research, Inc.

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