The Potential Approach to Bond and Currency Pricing

Markus Leippold () and Liuren Wu ()

Finance from EconWPA

Abstract: In this paper, we begin the modeling of bond and currency prices from the modeling of the state-price density satisfying basic properties of a potential. We provide extensive examples and show their implications on bond and currency pricing. Most classic short rate models are special cases of this general approach. We also investigate the connection to the Heath, Jarrow, and Morton model. One advantage of the potential approach resides in its ease in simultaneously modeling the yield curves of many countries and their exchange rates. The properties of exchange rates under each example are derived and we illustrate their possibility in explaining the forward premium puzzle.

Keywords: Potential approach; Interest Rate; Currency; International Term Structure Models; Heath-Jarrow-Morton; Forward Premium Puzzle (search for similar items in EconPapers)
JEL-codes: E43 C60 (search for similar items in EconPapers)
Date: 1999-03-15
Note: Type of Document - LaTex; prepared on IBM PC - PC-TEX; to print on HP/PostScript; pages: 50; figures: none. none
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:9903004

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