Random step functions model for interest rates

Eleanor Virag (), Fima C. Klebaner () and Konstantin Borovkov ()
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Eleanor Virag: Department of Mathematics and Statistics, University of Melbourne, Melbourne, Victoria 3010, Australia
Fima C. Klebaner: Department of Mathematics and Statistics, University of Melbourne, Melbourne, Victoria 3010, Australia
Konstantin Borovkov: Department of Mathematics and Statistics, University of Melbourne, Melbourne, Victoria 3010, Australia

Finance and Stochastics, 2003, vol. 7, issue 1, 123-143

Abstract: We propose a new model for pricing of bonds and their options based on the short rate when the latter exhibits a step function like behaviour. The model produces realistic looking spot rate curves, and allows one to derive explicit formulae for the yield curve and put and cap options. This model is appropriate for markets with pegged rates, such as the Australian market. We also give a general result on bond prices when the short rate is a sum of independent processes.

Keywords: Interest rates models; Markov point processes; jump processes; bonds; options on bonds (search for similar items in EconPapers)
JEL-codes: E43 G12 G13 (search for similar items in EconPapers)
Date: 2002-11-13
Note: received: July 2001; final version received: April 2002
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