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

  • Antonio Mele

    (Queen Mary, University of London)

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.econ.qmul.ac.uk/papers/doc/wp460.pdf
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Paper provided by Queen Mary University of London, School of Economics and Finance in its series Working Papers with number 460.

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Date of creation: Jun 2002
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Handle: RePEc:qmw:qmwecw:wp460
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