Inflation-rate Derivatives: From Market Model to Foreign Currency Analogy

Lixin Wu

Papers from arXiv.org

Abstract: In this paper, we establish a market model for the term structure of forward inflation rates based on the risk-neutral dynamics of nominal and real zero-coupon bonds. Under the market model, we can price inflation caplets as well as inflation swaptions with a formula similar to the Black's formula, thus justify the current market practice. We demonstrate how to further extend the market model to cope with volatility smiles. Moreover, we establish a consistency condition on the volatility of real zero-coupon bonds using arbitrage arguments, and with that re-derive the model of Jarrow and Yildirim (2003) with real forward rates based on "foreign currency analogy", and thus interconnect the two modeling paradigms.

Date: 2013-02
New Economics Papers: this item is included in nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://arxiv.org/pdf/1302.0574 Latest version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1302.0574

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators (help@arxiv.org).