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ARBITRAGE‐FREE MULTIFACTOR TERM STRUCTURE MODELS: A THEORY BASED ON STOCHASTIC CONTROL
Author(s) -
Gombani Andrea,
Runggaldier Wolfgang J.
Publication year - 2013
Publication title -
mathematical finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.98
H-Index - 81
eISSN - 1467-9965
pISSN - 0960-1627
DOI - 10.1111/j.1467-9965.2012.00527.x
Subject(s) - numéraire , term (time) , bond valuation , forward rate , bivariate analysis , bond , libor , affine term structure model , econometrics , mathematical economics , measure (data warehouse) , yield curve , quadratic equation , arbitrage , multivariate statistics , short rate , stochastic control , economics , mathematics , interest rate , mathematical optimization , computer science , optimal control , financial economics , finance , statistics , physics , geometry , quantum mechanics , database
We present an alternative approach to the pricing of bonds and bond derivatives in a multivariate factor model for the term structure of interest rates that is based on the solution of an optimal stochastic control problem. It can also be seen as an alternative to the classical approach of computing forward prices by forward measures and as such can be extended to other situations where traditionally a change of measure is involved based on a change of numeraire. We finally provide explicit formulas for the computation of bond options in a bivariate linear‐quadratic factor model.