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Bond pricing when the short term interest rate follows a threshold process

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  • Lemke, Wolfgang
  • Archontakis, Theofanis

Abstract

Using a stochastic discount factor approach, we derive the exact solution for arbitrage-free bond yields for the case that the short-term interest rate follows a threshold process with the intercept switching endogenously. The yield functions, mapping the one-month rate into n-period yields, respectively. This is in contrast to linear short-rate process which imply an affine yield function. The intervals for which convexity or concavity prevails increase with time to maturity.

Suggested Citation

  • Lemke, Wolfgang & Archontakis, Theofanis, 2006. "Bond pricing when the short term interest rate follows a threshold process," Discussion Paper Series 1: Economic Studies 2006,06, Deutsche Bundesbank.
    • Handle: RePEc:zbw:bubdp1:4243
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    Cited by:

    1. Renne Jean-Paul, 2017. "A model of the euro-area yield curve with discrete policy rates," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 21(1), pages 99-116, February.

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    More about this item

    Keywords

    Threshold process; term structure of interest rates; nonlinear yield function;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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