Advanced Search
MyIDEAS: Login to save this paper or follow this series

Higher order forward rate agreements and the smoothness of the term structure

Contents:

Author Info

  • Jaschke, Stefan R.
Registered author(s):

    Abstract

    This paper proposes linear higher order conditions on the term structure that allow to compute valuation bounds for any deterministic cash stream. Starting from bounds on the forward rate curve and its derivatives, which are nonlinear in the discount factors, we derive linear conditions that are only slightly less restrictive than the nonlinear conditions. The linearization of the term structure constraints has two advantages. First, the valuation bounds can be computed by highly developed LP solvers. Second, the constraints have an economic meaning as auxiliary cash streams. Thus, price discrepancies can be (1th'Sily translated into profitable trading strategies. Depending on the choice of the constraints on the forward rate curve the valuation bounds for cash streams can be very wide or very close. Arbitrage bounds are a special case of our general valuation bounds. On the other end of the extreme, the valuation bounds on the term structure itself behave like quadratic splines in the forward rate curve if the third order parameters are chosen in a restrictive way. The higher order conditions on the term structure are related to extremal event statistics of short-term interest rates. This puts the resulting valuation bounds conceptually dose to risk measures like value at risk. In fact, the proposed method is an example of a coherent risk measurre in a sense slightly more general as in the seminal paper by Artzner, Delbaen, Eber, and Heath (1998). Methods that calibrate a single price system to observed prices abound. Needed are valuation bounds that are based solely on economic assumptions. The valuation bounds under the linear higher order conditions on the term structure generalize arbitrage bounds and provide a sharper method when the arbitrage principle is too weak. --

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://econstor.eu/bitstream/10419/61714/1/722167261.pdf
    Download Restriction: no

    Bibliographic Info

    Paper provided by Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes in its series SFB 373 Discussion Papers with number 1999,13.

    as in new window
    Length:
    Date of creation: 1998
    Date of revision:
    Handle: RePEc:zbw:sfb373:199913

    Contact details of provider:
    Postal: Spandauer Str. 1,10178 Berlin
    Phone: +49-30-2093-5708
    Fax: +49-30-2093-5617
    Email:
    Web page: http://www.wiwi.hu-berlin.de/
    More information through EDIRC

    Related research

    Keywords: linear programming; arbitrage; term structure of interest rates; smoothing splines; forward rates; dominance;

    Find related papers by JEL classification:

    References

    No references listed on IDEAS
    You can help add them by filling out this form.

    Citations

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:zbw:sfb373:199913. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (ZBW - German National Library of Economics).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.