A yield-factor model of interest rates
Darrell Duffie,Rui Kan +1 more
TL;DR: In this article, the authors present a consistent and arbitrage-free multifactor model of the term structure of interest rates in which yields at selected fixed maturities follow a parametric muitivariate Markov diffusion process with stochastic volatility.
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Abstract: This paper presents a consistent and arbitrage-free multifactor model of the term structure of interest rates in which yields at selected fixed maturities follow a parametric muitivariate Markov diffusion process with “stochastic volatility.” the yield of any zero-coupon bond is taken to be a maturity-dependent affine combination of the selected “basis” set of yields. We provide necessary and sufficient conditions on the stochastic model for this affine representation. We include numerical techniques for solving the model, as well as numerical techniques for calculating the prices of term-structure derivative prices. the case of jump diffusions is also considered.
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Citations
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TL;DR: In this paper, a theoretical valuation formula for options is derived, based on the assumption that options are correctly priced in the market and it should not be possible to make sure profits by creating portfolios of long and short positions in options and their underlying stocks.
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An equilibrium characterization of the term structure
TL;DR: In this article, the authors derived a general form of the term structure of interest rates and showed that the expected rate of return on any bond in excess of the spot rate is proportional to its standard deviation.
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