Discrete-Time Continuous-State Interest Rate Models
This paper shows how to implement arbitrage-free models of the short-term interest rate in a discrete time setting that allows a continuum of rates at any particular date. Current models of the interest rate are either continuous time-continuous state models, such as the Vasicek or Cox, Ingersoll, and Ross models, or discrete time-discrete state models, such as the Hull and White model. A discrete-time process allows approximate valuation of a variety of interest-rate contingent claims that have no closed form solution -- for example, American style bond options. But binomial and trinomial models commonly employed in discrete-time settings also restrict interest rates to discrete outcomes. They have been shown in other contexts to have poor convergence properties. This paper uses numerical integration to evaluate the risk-neutral expectations that define the value of an interest-rate contingent claim. The efficiency of the technique is enhanced by summarizing information on the value of the claim at a given date in a continuous approximating function. The procedure gives a simple but flexible approach for handling arbitrage-free specifications of the short-rate process. Illustrations include the extended Vasicek model of Hull and White and the lognormal interest-rate process of Black and Karainsky.
To our knowledge, this item is not available for
download. To find whether it is available, there are three
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
|Date of creation:||01 Mar 1999|
|Contact details of provider:|| Postal: CEF99, Boston College, Department of Economics, Chestnut Hill MA 02467 USA|
Web page: http://fmwww.bc.edu/CEF99/
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:sce:scecf9:913. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum)
If references are entirely missing, you can add them using this form.