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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.

Suggested Citation

  • Robert J. Elliott & Katsumasa Nishide, 2013. "Pricing of Discount Bonds with a Markov Switching Regime," KIER Working Papers 859, Kyoto University, Institute of Economic Research.
  • Handle: RePEc:kyo:wpaper:859

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    References listed on IDEAS

    1. Camilla LandÊn, 2000. "Bond pricing in a hidden Markov model of the short rate," Finance and Stochastics, Springer, vol. 4(4), pages 371-389.
    2. Asbjørn T. Hansen & Rolf Poulsen, 2000. "A simple regime switching term structure model," Finance and Stochastics, Springer, vol. 4(4), pages 409-429.
    3. 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.
    4. Darrell Duffie & Jun Pan & Kenneth Singleton, 2000. "Transform Analysis and Asset Pricing for Affine Jump-Diffusions," Econometrica, Econometric Society, vol. 68(6), pages 1343-1376, November.
    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. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-592.
    7. Darrell Duffie & Rui Kan, 1996. "A Yield-Factor Model Of Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(4), pages 379-406.
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    Cited by:

    1. Robert J. Elliott & Katsumasa Nishide & Carlton‐James U. Osakwe, 2016. "Heston‐Type Stochastic Volatility with a Markov Switching Regime," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 36(9), pages 902-919, September.
    2. Mengzhe Zhang & Leunglung Chan, 2016. "Saddlepoint approximations to option price in a regime-switching model," Annals of Finance, Springer, vol. 12(1), pages 55-69, February.
    3. Daniela Neykova & Marcos Escobar & Rudi Zagst, 2015. "Optimal investment in multidimensional Markov-modulated affine models," Annals of Finance, Springer, vol. 11(3), pages 503-530, November.

    More about this item


    Investment; Bond pricing; term structure; Markov switching regime; Vasicek model; CIR model; stochastic flows.;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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