On the Pricing and Hedging of Long Dated Zero Coupon Bonds

Eckhard Platen ()

No 185, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: The pricing and hedging of long dated derivative contracts is a challenging area of research. As a result of utility indifference pricing for general payoffs the growth optimal portfolio turns out to be the appropriate numeraire or benchmark with the real world probability measure as corresponding pricing measure. This concept of real world pricing can be applied for valuing long dated derivatives. An equivalent risk neutral probability measure does not need to exist under this benchmark approach. This paper develops a parsimonious model for a stock index dynamics, which is based on a time transformed squared Bessel process. It uses a diversified world stock index as proxy for the growth optimal portfolio. Surprisingly low prices result for long dated zero coupon bonds that can be replicated using historical data. Such prices and hedges are difficult to explain under the prevailing risk neutral approach.

Keywords: growth optimal portfolio; benckmark approach; real world pricing; expected utility maximization; utility indifference pricing; long dated zero coupon bonds; minimal market model (search for similar items in EconPapers)
JEL-codes: G10 G13 (search for similar items in EconPapers)
Pages: 18 pages
Date: 2006-09-01
New Economics Papers: this item is included in nep-fin, nep-fmk and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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