On the Geometry of Interest Rate Models
In this paper, which is a substantial extension of the earlier essay Björk (2001), we give an overview of some recent work on the geometric properties of the evolution of the forward rate curve in an arbitrage free bond market. The main problems to be discussed are as follows. 1. When is a given forward rate model consistent with a given family of forward rate curves? 2. When can the inherently infinite dimensional forward rate process be realized by means of a Markovian finite dimensional state space model. We consider interest rate models of Heath-Jarrow-Morton type, where the forward rates are driven by a multidimensional Wiener process, and where he volatility is allowed to be an arbitrary smooth functional of the present forward rate curve. Within this framework we give necessary and sufficient conditions for consistency, as well as for the existence of a finite dimensional realization, in terms of the forward rate volatilities. We also study stochastic volatility HJM models, and we provide a systematic method for the construction of concrete realizations.
|Date of creation:||24 Nov 2003|
|Note:||To apppear in "Springer Lecture Notes in Mathematics"|
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- Ernst Eberlein & Sebastian Raible, 1999. "Term Structure Models Driven by General Lévy Processes," Mathematical Finance, Wiley Blackwell, vol. 9(1), pages 31-53.
- Tomas Björk & Bent Jesper Christensen, 1999.
"Interest Rate Dynamics and Consistent Forward Rate Curves,"
Wiley Blackwell, vol. 9(4), pages 323-348.
- Björk, Tomas & Christensen, Bent Jesper, 1997. "Interest Rate Dynamics and Consistent Forward Rate Curves," SSE/EFI Working Paper Series in Economics and Finance 209, Stockholm School of Economics.
- Camilla Landén & Tomas Björk, 2002. "On the construction of finite dimensional realizations for nonlinear forward rate models," Finance and Stochastics, Springer, vol. 6(3), pages 303-331.
- Peter Ritchken & L. Sankarasubramanian, 1995. "Volatility Structures Of Forward Rates And The Dynamics Of The Term Structure," Mathematical Finance, Wiley Blackwell, vol. 5(1), pages 55-72.
- R. Bhar & C. Chiarella, 1997. "Transformation of Heath?Jarrow?Morton models to Markovian systems," The European Journal of Finance, Taylor & Francis Journals, vol. 3(1), pages 1-26.
- Ram Bhar & Carl Chiarella, 1995. "Transformation of Heath-Jarrow-Morton Models to Markovian Systems," Working Paper Series 53, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
- John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters,in: Theory Of Valuation, chapter 5, pages 129-164 World Scientific Publishing Co. Pte. Ltd..
- Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
- Carl Chiarella & Oh Kang Kwon, 2001. "Forward rate dependent Markovian transformations of the Heath-Jarrow-Morton term structure model," Finance and Stochastics, Springer, vol. 5(2), pages 237-257.
- Carl Chiarella & Oh-Kang Kwon, 1999. "Forward Rate Dependent Markovian Transformations of the Heath-Jarrow-Morton Term Structure Model," Research Paper Series 5, Quantitative Finance Research Centre, University of Technology, Sydney.
- Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-592.
- David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305 World Scientific Publishing Co. Pte. Ltd..
- Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January.
- Tomas BjÃrk & Andrea Gombani, 1999. "Minimal realizations of interest rate models," Finance and Stochastics, Springer, vol. 3(4), pages 413-432.
- Björk, Tomas & Landén, Camilla & Svensson, Lars, 2002. "Finite dimensional Markovian realizations for stochastic volatility forward rate models," SSE/EFI Working Paper Series in Economics and Finance 498, Stockholm School of Economics, revised 06 May 2002.
- Ho, Thomas S Y & Lee, Sang-bin, 1986. " Term Structure Movements and Pricing Interest Rate Contingent Claims," Journal of Finance, American Finance Association, vol. 41(5), pages 1011-1029, December. Full references (including those not matched with items on IDEAS)
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