Abstract:
This chapter surveys the literature on fixed-income pricing models, including dynamic term-structure models, and interest-rate sensitive, derivative pricing models. Our overview of conceptual approaches highlights the tradeoffs that have emerged between the complexity of the probability model for the "risk factors[equal, rising dots], data availability, the pricing objective, and the tractability of the resulting pricing model. Initially, we examine term-structure models that price both bonds (default-free and defaultable) and fixed-income derivatives with payoffs in terms of prices or yields on these bonds. These include affine, quadratic-Gaussian, and various stochastic volatility models of the term structure. Then we turn to models designed to price fixed-income derivatives, taking the current yield curve as an input into the pricing framework. These include models based on forward rates and the LIBOR and Swaption Market models.