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Copyright © 2011 Claremont Center for the Mathematical Sciences

When

Start: 10/10/2013 - 4:00pm

End : 10/10/2013 - 5:00pm

End : 10/10/2013 - 5:00pm

Category

Statistics/OR/Math Finance Seminar

Speaker

Anders Trolle, EPFL, Switzerland

Abstract

We introduce the class of linear rational term structure models, where the state price density is modeled such that bond prices become linear-rational functions of the current state. This class is highly tractable with several distinct advantages: i) ensures non-negative interest rates, ii) easily accommodates unspanned factors affecting volatility and risk premia, and iii) has analytical solutions to swaptions. For comparison, affine term structure models can match either i) or ii), but not both simultaneously, and never iii). A parsimonious specification of the model with three term structure factors and one, or possibly two, unspanned factors has a very good fit to both interest rate swaps and swaptions since 1997. In particular, the model captures well the dynamics of the term structure and volatility during the recent period of near-zero interest rates.

Where

Roberts South 105, CMC