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Impulse Control of Interest Rates

45 Pages Posted: 6 Feb 2013 Last revised: 1 Oct 2013

Daniel Mitchell

University of Texas at Austin - Red McCombs School of Business

Haolin Feng

Lingnan (University) College, Sun Yat-sen University

Kumar Muthuraman

University of Texas at Austin - McCombs School of Business

Date Written: February 5, 2013

Abstract

Most academic studies on interest rate dynamics and derivative pricing assume that interest rates move freely in an open market, while there has been relatively little attention paid to the situation where a nation’s central bank has the power to intervene in the interest rate market. This paper examines the effect that a central bank's interventions have on longer term interest rate securities. We model the central bank’s intervention as an impulse control problem on a very general class of stochastic processes. As there is no known solution methodology to solve the posed problem, we develop a computational method and provide all the necessary theoretical guarantees. Using this method we solve for the central bank’s optimal control policy and also study the effect of this on longer term interest rate securities using a change of measure. The method developed here can easily be applied to a very wide range of impulse control problems beyond the realm of interest rate models.

JEL Classification: C61

Suggested Citation

Mitchell, Daniel and Feng, Haolin and Muthuraman, Kumar, Impulse Control of Interest Rates (February 5, 2013). Available at SSRN: https://ssrn.com/abstract=2212478 or http://dx.doi.org/10.2139/ssrn.2212478

Daniel Mitchell (Contact Author)

University of Texas at Austin - Red McCombs School of Business ( email )

Austin, TX 78712
United States

Haolin Feng

Lingnan (University) College, Sun Yat-sen University ( email )

135 Xin Gang Xi Road
Guangzhou, Guangdong 510275
China

Kumar Muthuraman

University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

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