A simple regime switching term structure model

Asbjørn T. Hansen and Rolf Poulsen
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Asbjørn T. Hansen: Global Equities, Dresdner Kleinwort Benson, 20 Fenchurch Street, London EC3P 3DB, UK
Rolf Poulsen: Department of Statistics and Operations Research, University of Copenhagen, Universitetsparken 5, DK-2100, Denmark Manuscript

Finance and Stochastics, 2000, vol. 4, issue 4, 409-429

Abstract: We extend the short rate model of Vasicek (1977) to include jumps in the local mean. Conditions ensuring existence of a unique equivalent martingale measure are given, implying that the model is arbitrage-free and complete. We develop efficient numerical methods for computation of zero coupon bond prices, illustrate how the model is easily calibrated to market data and show how other interest rate derivatives can be priced.

Keywords: Regime switching; term structure of interest rates; numerical methods; option pricing (search for similar items in EconPapers)
JEL-codes: C15 C63 E43 G13 (search for similar items in EconPapers)
Date: 2000-08-11
Note: received: March 1998; final version received: November 1999
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Citations: View citations in EconPapers (16)

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