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A tractable market model with jumps for pricing short-term interest rate derivatives


  • Y. Samuelides
  • E. Nahum


Short-term interest rate derivatives present a few unresolved problems. It is not obvious which pricing model to use, and the usual Heath-Jarrow-Morton type models seem insufficient to describe the risk they entail. Moreover, the hedging process is fairly delicate as the liquidity of short-term products cannot always be relied upon. In this paper, we justify the use of a market model with jumps to price these products. The main advantage of this approach is two fold. First, we will show how realistic such a model proves to be. Then, using justified approximations, the market model with jumps is made very tractable. Finally, the hedging issue is resolved by describing a dynamic delta-hedging strategy provided by the model in addition to a static vega-hedging strategy designed to use the relevant liquid products at the trader's disposal.

Suggested Citation

  • Y. Samuelides & E. Nahum, 2001. "A tractable market model with jumps for pricing short-term interest rate derivatives," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 270-283.
  • Handle: RePEc:taf:quantf:v:1:y:2001:i:2:p:270-283
    DOI: 10.1088/1469-7688/1/2/309

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    Cited by:

    1. Nicola Bruti-Liberati, 2007. "Numerical Solution of Stochastic Differential Equations with Jumps in Finance," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 1.
    2. Nicola Bruti-Liberati & Eckhard Platen, 2006. "On Weak Predictor-Corrector Schemes for Jump-Diffusion Processes in Finance," Research Paper Series 179, Quantitative Finance Research Centre, University of Technology, Sydney.

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