A GENERALIZED ORNSTEIN-UHLENBECK PROCESS OF YIELD RATES CALIBRATED WITH STRIPS

J. F. Carrière
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J. F. Carrière: Mathematical Sciences, University of Alberta, Edmonton, T6G 2Gl, Canada

Chapter 10 in Quantitative Analysis in Financial Markets:Collected Papers of the New York University Mathematical Finance Seminar(Volume III), 2002, pp 222-246 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractIn this article, we present a Gaussian multivariate factor model of the term structure of interest rates. We show that under a martingale valuation law, the factors follow a generalized multivariate Ornstein-Uhlenbeck process. We also give an explicit expression for Green's function which leads to a complete characterization of value functions for European-type securities. The model's linear and Gaussian structure yields a simple model where estimation and calibration is relatively easy to do. Using yield data on stripped bonds, we calibrate our model and demonstrate that the Gaussian assumption is not unreasonable. The model accurately explains the dynamics of the whole yield curve for periods of at least one year.

Keywords: Quantitative Analysis; Financial Markets (search for similar items in EconPapers)
Date: 2002
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