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Short-rate models with stochastic discontinuities: a PDE approach

Author

Listed:
  • Alessandro Calvia
  • Marzia De Donno
  • Chiara Guardasoni
  • Simona Sanfelici

Abstract

With the reform of interest rate benchmarks, interbank offered rates (IBORs) like LIBOR have been replaced by risk-free rates (RFRs), such as the Secured Overnight Financing Rate (SOFR) in the U.S. and the Euro Short-Term Rate (\euro STR) in Europe. These rates exhibit characteristics like jumps and spikes that correspond to specific market events, driven by regulatory and liquidity constraints. To capture these characteristics, this paper considers a general short-rate model that incorporates discontinuities at fixed times with random sizes. Within this framework, we introduce a PDE-based approach for pricing interest rate derivatives and establish, under suitable assumptions, a Feynman-Ka\v{c} representation for the solution. For affine models, we derive (quasi) closed-form solutions, while for the general case, we develop numerical methods to solve the resulting PDEs.

Suggested Citation

  • Alessandro Calvia & Marzia De Donno & Chiara Guardasoni & Simona Sanfelici, 2025. "Short-rate models with stochastic discontinuities: a PDE approach," Papers 2510.04289, arXiv.org.
    • Handle: RePEc:arx:papers:2510.04289
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    References listed on IDEAS

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    Cited by:

    1. Flavio Angelini & Stefano Herzel & Marco Nicolosi, 2025. "Modeling Euro Area Benchmark Rates After the End of LIBOR," CEIS Research Paper 613, Tor Vergata University, CEIS, revised 07 Oct 2025.

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