Approximating Heath-Jarrow-Morton Non-Markovian Term Structure of Interest Rate Models with Markovian Systems

Ram Bhar and Carl Chiarella
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Ram Bhar: School of Banking and Finance, University of New South Wales

No 76, Working Paper Series from Finance Discipline Group, UTS Business School, University of Technology, Sydney

Abstract: We consider a Heath-Jarrow-Morton models for the term structure of interest rates in which the forward rate volatility is a function of the instantaneous spot rate of interest, a set of dicrete forward rates and time to maturity of the bond. We show how the stochastic dynamics may be expressed as a system of Markovian stochastic differential equations. We obtain the partial differential equation which allows the pricing of contingent claims in this framework.

Pages: 25 pages
Date: 2000-09-01
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