Bond pricing in a hidden Markov model of the short rate
2000 (English)In: Finance and Stochastics, ISSN 0949-2984, E-ISSN 1432-1122, Vol. 4, no 4, 371-389 p.Article in journal (Refereed) Published
We consider a diffusion type model for the short rate, where the drift and diffusion parameters are modulated by an underlying Markov process. The underlying Markov process is assumed to have a stochastic differential driven by Wiener processes and a marked point process. The model for the short rate thus falls within the category of hidden Markov models. For this model we look at the bond pricing problem. In order to obtain more concrete results we introduce the notion of a semi-affine term structure and give sufficient conditions for the existence of such a term structure. For a special case, when the underlying process is a Markov chain with only two states, we obtain a closed form expression for bond prices. Furthermore we consider the pricing problem when the modulating process can not be directly observed. It turns out that pricing in this context may be viewed as a filtering problem.
Place, publisher, year, edition, pages
2000. Vol. 4, no 4, 371-389 p.
Bond market, term structure of interest rates, regime shifts, hidden Markov model
IdentifiersURN: urn:nbn:se:kth:diva-12540DOI: 10.1007/PL00013526OAI: oai:DiVA.org:kth-12540DiVA: diva2:317758
QC 201005052010-05-052010-05-052010-05-05Bibliographically approved