Bond pricing when the short-term interest rate follows a threshold process

Wolfgang Lemke and Theofanis Archontakis

Quantitative Finance, 2008, vol. 8, issue 8, 811-822

Abstract: This paper derives analytical solutions for arbitrage-free bond yields when the short-term interest rate follows an autoregressive process with the intercept switching endogenously. This process from the SETAR family is especially suited to capture the near-unit-root behaviour typically observed in the evolution of short-term interest rates. The derived yield functions, mapping the one-month rate into n-period yields, exhibit a convex/concave shape to the left and right of the threshold value, respectively, a pattern which is also found in US bond yield data. The longer the time to maturity, the more distinct the nonlinearity of the yield function becomes.

Keywords: Bond pricing; Term structure of interest rates; Threshold models (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (2)

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Working Paper: Bond pricing when the short term interest rate follows a threshold process (2006)
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DOI: 10.1080/14697680701691451

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