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

Listed author(s):
  • A. Mele

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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File URL: http://www.u-cergy.fr/IMG/documents//2000-39bisMele.pdf
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Paper provided by THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise in its series THEMA Working Papers with number 2000-39.

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Date of creation: 2000
Handle: RePEc:ema:worpap:2000-39
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