Bond valuation under a discrete-time regime-switching term-structure model and its continuous-time extension
Date
2011
Journal Title
Journal ISSN
Volume Title
Publisher
Emerald
Abstract
Purpose – The purpose of this paper is to consider a discrete-time, Markov, regime-switching, affine
term-structure model for valuing bonds and other interest rate securities. The proposed model
incorporates the impact of structural changes in (macro)-economic conditions on interest-rate
dynamics. The market in the proposed model is, in general, incomplete. A modified version of the
Esscher transform, namely, a double Esscher transform, is used to specify a price kernel so that both
market and economic risks are taken into account.
Design/methodology/approach – The market in the proposed model is, in general, incomplete.
A modified version of the Esscher transform, namely, a double Esscher transform, is used to specify a
price kernel so that both market and economic risks are taken into account.
Findings – The authors derive a simple way to give exponential affine forms of bond prices using
backward induction. The authors also consider a continuous-time extension of the model and derive
exponential affine forms of bond prices using the concept of stochastic flows.
Description
Article deposited according to publisher policy posted on SHERPA/ROMEO, June 13, 2012
Keywords
bonds, Securities
Citation
Robert J. Elliott, Tak Kuen Siu, Alex Badescu, (2011) "Bond valuation under a discrete-time regime-switching term-structure model and its continuous-time extension", Managerial Finance, Vol. 37 Iss: 11, pp.1025 - 1047