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Pricing of Discount Bonds with a Markov Switching Regime

  • Robert J. Elliott

    ()

    (School of Mathematics, University of Adelaide, Center for Applied Financial Studies, University of South Australia, Haskayne School of Business, University of Calgary)

  • Katsumasa Nishide

    ()

    (Department of Economics, Yokohama National University)

We consider a Markov switching regime and price a discount bond using two popular models for the short rate, the Vasicek- and CIR-dynamics. In both cases, an explicit formula is obtained for the bond price which includes the solution of a matrix ODE. Our model is easy to calculate and captures the effect of regime uncertainty on the price and the term structure.

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File URL: http://www.kier.kyoto-u.ac.jp/DP/DP859.pdf
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Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 859.

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Date of creation: Apr 2013
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Handle: RePEc:kyo:wpaper:859
Contact details of provider: Postal: Yoshida-Honmachi, Sakyo-ku, Kyoto 606-8501
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Web page: http://www.kier.kyoto-u.ac.jp/eng/index.html
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  1. Darrell Duffie & Jun Pan & Kenneth Singleton, 1999. "Transform Analysis and Asset Pricing for Affine Jump-Diffusions," NBER Working Papers 7105, National Bureau of Economic Research, Inc.
  2. Robert Elliott & Rogemar Mamon, 2002. "An interest rate model with a Markovian mean reverting level," Quantitative Finance, Taylor & Francis Journals, vol. 2(6), pages 454-458.
  3. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-92.
  4. Camilla LandÊn, 2000. "Bond pricing in a hidden Markov model of the short rate," Finance and Stochastics, Springer, vol. 4(4), pages 371-389.
  5. Robert J. Elliott & John van der Hoek, 2001. "Stochastic flows and the forward measure," Finance and Stochastics, Springer, vol. 5(4), pages 511-525.
  6. Darrell Duffie & Rui Kan, 1996. "A Yield-Factor Model Of Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(4), pages 379-406.
  7. Asbjørn T. Hansen & Rolf Poulsen, 2000. "A simple regime switching term structure model," Finance and Stochastics, Springer, vol. 4(4), pages 409-429.
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