A FILTERING APPROACH TO PRICING IN MULTIFACTOR TERM STRUCTURE MODELS

Andrea Gombani () and Wolfgang J. Runggaldier ()
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Andrea Gombani: Ladseb-Cnr, Corso Stati Uniti 4, 35127 Padova, Italy
Wolfgang J. Runggaldier: Dipartimento di Matematica Pura ed Applicata, Universitá di Padova, Via Belzoni 7, 35131 – Padova, Italy

International Journal of Theoretical and Applied Finance (IJTAF), 2001, vol. 04, issue 02, 303-320

Abstract: We present an approach for the pricing of illiquid bonds (and bond derivatives) in an arbitrage-free way and which is consistent with the observed prices of liquid bonds. The basic model is a multifactor term structure model with abstract latent factors. The approach is based on stochastic filtering techniques, leading to a continuous update of the distribution of the latent factors on the basis of the information coming from the observations. This allows our model to continuously "track" the real market.

Date: 2001
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DOI: 10.1142/S0219024901000973

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