Finite-dimensional Realizations of Regime-switching HJM Models

Mikael Elhouar

Applied Mathematical Finance, 2008, vol. 15, issue 4, 331-354

Abstract: This paper studies Heath-Jarrow-Morton-type models with regime-switching stochastic volatility. In this setting the forward rate volatility is allowed to depend on the current forward rate curve as well as on a continuous time Markov chain y with finitely many states. Employing the framework developed by Bjork and Svensson we find necessary and sufficient conditions on the volatility guaranteeing the representation of the forward rate process by a finite-dimensional Markovian state space model. These conditions allow us to investigate regime-switching generalizations of some well-known models such as those by Ho-Lee, Hull-White, and Cox-Ingersoll-Ross.

Keywords: HJM models; forward rates; stochastic volatility; state space models; Markov chains in continuous time (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (3)

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DOI: 10.1080/13504860801987133

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