ARBITRAGE‐FREE MULTIFACTOR TERM STRUCTURE MODELS: A THEORY BASED ON STOCHASTIC CONTROL. (19th June 2012)

• Record Type: Journal Article
• Authors: Gombani, Andrea; Runggaldier, Wolfgang J.
• Is Part Of: Mathematical finance. Volume 23:Number 4(2013:Oct.)
• Page Start: 659
• Page End: 686
• Publication Date: 2012-06-19
• Subjects: multifactor term structures -- bond option pricing -- stochastic control; Business mathematics -- Periodicals; 332
• DOI: 10.1111/j.1467-9965.2012.00527.x
• Languages: English
• ISSNs: 0960-1627

Abstract

Abstract : We present an alternative approach to the pricing of bonds and bond derivatives in a multivariate factor model for the term structure of interest rates that is based on the solution of an optimal stochastic control problem. It can also be seen as an alternative to the classical approach of computing forward prices by forward measures and as such can be extended to other situations where traditionally a change of measure is involved based on a change of numeraire. We finally provide explicit formulas for the computation of bond options in a bivariate linear‐quadratic factor model.