Results 11  20
of
105
LinearQuadratic JumpDiffusion Modeling with Application to Stochastic Volatility
, 2004
"... We aim at accommodating the existing affine jumpdiffusion and quadratic models under the same roof, namely the linearquadratic jumpdiffusion (LQJD) class. We give a complete characterization of the dynamics of this class of models by stating explicitly a list of structural constraints, and comput ..."
Abstract

Cited by 26 (1 self)
 Add to MetaCart
We aim at accommodating the existing affine jumpdiffusion and quadratic models under the same roof, namely the linearquadratic jumpdiffusion (LQJD) class. We give a complete characterization of the dynamics of this class of models by stating explicitly a list of structural constraints, and compute standard and extended transforms relevant to asset pricing. We show that the LQJD class can be embedded into the affine class through use of an augmented state vector, and further establish that a onetoone equivalence relationship holds between both classes in terms of transform analysis. An option pricing application to multifactor stochastic volatility models reveals that adding nonlinearity into the model would reduce pricing errors and yield parameter estimates that are more in line with sensible economic interpretation.
Does the failure of the expectations hypothesis matter for longterm investors?
, 2003
"... We consider the consumption and portfolio choice problem of a longrun investor when the term structure is affine and when the investor has access to nominal bonds and a stock portfolio. In the presence of unhedgeable inflation risk, there exist multiple pricing kernels that produce the same bond pr ..."
Abstract

Cited by 25 (7 self)
 Add to MetaCart
We consider the consumption and portfolio choice problem of a longrun investor when the term structure is affine and when the investor has access to nominal bonds and a stock portfolio. In the presence of unhedgeable inflation risk, there exist multiple pricing kernels that produce the same bond prices, but a unique pricing kernel equal to the marginal utility of the investor. We apply our method to a threefactor Gaussian model with a timevarying price of risk that captures the failure of the expectations hypothesis seen in the data. We extend this model to account for timevarying expected inflation, and estimate the model with both inflation and term structure data. The estimates imply that the bond portfolio for the longrun investor looks very different from the portfolio of a meanvariance optimizer. In particular, the desire to hedge changes in term premia generates large hedging demands for longterm bonds.
Design and Estimation of MultiCurrency Quadratic Models
 Review of Finance
"... Abstract. To simultaneously account for the properties of interestrate term structure and foreign exchange rates within one arbitragefree framework, we propose a class of multicurrency quadratic models (MCQM) with an (m + n) factor structure in the pricing kernel of each economy. The m factors mo ..."
Abstract

Cited by 18 (2 self)
 Add to MetaCart
Abstract. To simultaneously account for the properties of interestrate term structure and foreign exchange rates within one arbitragefree framework, we propose a class of multicurrency quadratic models (MCQM) with an (m + n) factor structure in the pricing kernel of each economy. The m factors model the term structure of interest rates. The n factors capture the portion of the exchange rate movement that is independent of the term structure. Our modeling framework represents the first in the literature that not only explicitly allows independent currency movement, but also guarantees internal consistency across all economies without imposing any artificial constraints on the exchange rate dynamics. We estimate a series of multicurrency quadratic models using U.S. and Japanese LIBOR and swap rates and the exchange rate between the two economies. Estimation shows that independent currency factors are essential in releasing the tension between the currency movement and the term structure of interest rates. JEL Classification: G12, G13, E43 1.
Efficient rank reduction of correlation matrices
 Linear Algebra Appl
"... Abstract. Geometric optimisation algorithms are developed that efficiently find the nearest lowrank correlation matrix. We show, in numerical tests, that our methods compare favourably to the existing methods in the literature. The connection with the Lagrange multiplier method is established, alon ..."
Abstract

Cited by 16 (0 self)
 Add to MetaCart
Abstract. Geometric optimisation algorithms are developed that efficiently find the nearest lowrank correlation matrix. We show, in numerical tests, that our methods compare favourably to the existing methods in the literature. The connection with the Lagrange multiplier method is established, along with an identification of whether a local minimum is a global minimum. An additional benefit of the geometric approach is that any weighted norm can be applied. The problem of finding the nearest lowrank correlation matrix occurs as part of the calibration of multifactor interest rate market models to correlation. Key words. geometric optimisation, correlation matrix, rank, LIBOR market model 1. Introduction. The
F.: Interest rate caps smile too! But can the Libor market models capture it
 J. Financ., http://www.afajof.org/afa/forthcoming/2495.pdf
"... Using 3 years of interest rate caps price data, we provide a comprehensive documentation of volatility smiles in the caps market. To capture the volatility smiles, we develop a multifactor term structure model with stochastic volatility and jumps that yields a closedform formula for cap prices. We ..."
Abstract

Cited by 14 (2 self)
 Add to MetaCart
Using 3 years of interest rate caps price data, we provide a comprehensive documentation of volatility smiles in the caps market. To capture the volatility smiles, we develop a multifactor term structure model with stochastic volatility and jumps that yields a closedform formula for cap prices. We show that although a threefactor stochastic volatility model can price atthemoney caps well, significant negative jumps in interest rates are needed to capture the smile. The volatility smile contains information that is not available using only atthemoney caps, and this information is important for understanding term structure models. THE EXTENSIVE LITERATURE ON MULTIFACTOR DYNAMIC term structure models (hereafter, DTSMs) of the last decade mainly focuses on explaining bond yields
General quadratic term structures of bond, futures and forward prices
 SSE/EFI Working paper Series in Economics and Finance
, 2004
"... For finite dimensional factor models, the paper studies general quadratic term structures. These term structures include as special cases the affine term structures and the Gaussian quadratic term structures, previously studied in the literature. We show, however, that there are other, nonGaussia ..."
Abstract

Cited by 12 (4 self)
 Add to MetaCart
(Show Context)
For finite dimensional factor models, the paper studies general quadratic term structures. These term structures include as special cases the affine term structures and the Gaussian quadratic term structures, previously studied in the literature. We show, however, that there are other, nonGaussian, quadratic term structures and derive sufficient conditions for the existence of these general quadratic term structures for bond, futures and forward prices. As forward prices are martingales under the Tforward measure, their term structure equation depends on properties of bond prices ’ term structure. We exploit the connection with the bond prices term structure and show that even in quadratic short rate settings we can have affine term structures for forward prices. Finally, we show how the study of futures prices is naturally embedded in a study of forward prices and show that the difference between the two prices have to do with the correlation between bond prices and the price process of the underlying to the forward contract and this difference may be deterministic in some (nontrivial) stochastic interest rate settings. Key words: term structure, bond price, futures price, forward price, affine term structure, quadratic term structure.
Nonparametric Estimation of StatePrice Densities Implicit in Interest Rate Cap Prices
 Review of Financial Studies
, 2009
"... Based on a multivariate extension of the constrained locally polynomial estimator of AtSahalia and Duarte (2003), we provide nonparametric estimates of the probability densities of LIBOR rates under forward martingale measures and the stateprice densities (SPDs) implicit in interest rate cap price ..."
Abstract

Cited by 11 (1 self)
 Add to MetaCart
Based on a multivariate extension of the constrained locally polynomial estimator of AtSahalia and Duarte (2003), we provide nonparametric estimates of the probability densities of LIBOR rates under forward martingale measures and the stateprice densities (SPDs) implicit in interest rate cap prices conditional on the slope and volatility factors of LIBOR rates. Both the forward densities and the SPDs depend signicantly on the volatility of LIBOR rates, and there is a signicant impact of mortgage prepayment activities on the forward densities. The SPDs exhibit a pronounced Ushape as a function of future LIBOR rates, suggesting that the state prices are high at both extremely low and high interest rates, which tend to be associated with periods of economic recessions and high in
ations, respectively. Our results provide nonparametric evidence of unspanned stochastic volatility and suggest that the unspanned factors could be partly driven by renancing activities in the mortgage markets. Overthecounter interest rate derivatives, such as caps and swaptions, are among the most widely traded interest rate derivatives in the world. According to the Bank for International Settlements, in recent years, the notional value of caps and swaptions exceeds $ 10 trillion, which is many times
Corporate Credit Default Swap Liquidity and its Implications for Corporate Bond Spreads
 The Journal of Fixed Income
, 2010
"... The turn of the century has seen the development and growth of more efficient vehicles for transferring the credit risk of individual credit exposures or a portfolio of them. This growth has been fostered by the emergence of credit derivatives, in particular credit default swaps (CDSs). In a CDS tra ..."
Abstract

Cited by 11 (0 self)
 Add to MetaCart
The turn of the century has seen the development and growth of more efficient vehicles for transferring the credit risk of individual credit exposures or a portfolio of them. This growth has been fostered by the emergence of credit derivatives, in particular credit default swaps (CDSs). In a CDS trade, a credit protection buyer acquires credit protection from the counterparty by paying a premium. The CDS swap premium has been viewed as a clean representation of credit risk. As a result, in the past few years, researchers have used data on CDS trades where the reference entity is a corporation to study the liquidity component of corporate bond spreads. Using a transaction dataset, we discover very large bidask spreads in CDS quotes. With a twofactor model, we show that such large bidask spreads can profoundly affect the estimation of credit risk, which in turn has a significant effect on the estimation of the liquidity spread for corporate bonds. Contrary to the literature, we show that while the bond and CDS markets appear to have two different values for the credit spread, once liquidity is accounted for we no longer find such a difference.
Expectations, Bond Yields and Monetary Policy
, 2005
"... Through explicitly incorporating analysts ’ forecasts as observable factors in a dynamic arbitragefree model of the yield curve, this paper proposes a framework for studying the impact of shifts in market sentiment on interest rates of all maturities. An empirical examination reveals that survey exp ..."
Abstract

Cited by 10 (0 self)
 Add to MetaCart
Through explicitly incorporating analysts ’ forecasts as observable factors in a dynamic arbitragefree model of the yield curve, this paper proposes a framework for studying the impact of shifts in market sentiment on interest rates of all maturities. An empirical examination reveals that survey expectations about inflation, output growth and the anticipated path of monetary policy actions contain important information for explaining movements in bond yields. Although perceptions about inflation are largely responsible for movements in longterm interest rates, an explicit slope factor is necessary to adequately capture the dynamics of the yield curve. Macroeconomic forecasts play an important role in explaining timevariation in the market prices of risk, with forecasted GDP growth playing a dominant role. The estimated coefficients from a forwardlooking monetary policy rule support the assertion that the central bank preemptively reacts to inflationary expectations while suggesting patience in accommodating real output growth expectations. Models of this type may provide traders and policymakers with a new set of tools for formally assessing the reaction of bond yields to shifts in market expectations due to the arrival of news or central bank statements and announcements.
Linearquadratic jumpdiffusion modeling
 Mathematical Finance
, 2007
"... We aim at accommodating the existing affine jumpdiffusion and quadratic models under the same roof, namely the linearquadratic jumpdiffusion (LQJD) class. We give a complete characterization of the dynamics of this class by stating explicitly the structural constraints, as well as the admissibili ..."
Abstract

Cited by 9 (1 self)
 Add to MetaCart
We aim at accommodating the existing affine jumpdiffusion and quadratic models under the same roof, namely the linearquadratic jumpdiffusion (LQJD) class. We give a complete characterization of the dynamics of this class by stating explicitly the structural constraints, as well as the admissibility conditions. This allows us to carry out a specification analysis for the 3factor LQJD models. We compute the standard transform of the state vector relevant to asset pricing up to a system of ordinary differential equations. We show that the LQJD class can be embedded into the affine class through use of an augmented state vector. This establishes a onetoone equivalence relationship between both classes in terms of transform analysis. CHENG, P., SCAILLET, Olivier. LinearQuadratic JumpDiffusion Modeling. 2006 Available at: