A Tractable Multi-Factor Dynamic Term-Structure Model for Risk Management

30 Pages Posted: 2 Mar 2013 Last revised: 1 Mar 2017

Michael Henseler

German Finance Agency

Christoph Peters

German Finance Agency

Roland C. Seydel

German Finance Agency

Date Written: February 23, 2017

Abstract

We present an affine arbitrage-free dynamic term-structure model based on a representation of instantaneous forward rates as sum of exponentials. The model, which is Gaussian and belongs to the class of Heath-Jarrow-Morton-type models, is intuitively appealing as a suitable linear combination of the stochastic factors can be interpreted as stochastic evolution of stable principal components of the yield curve. Focusing on applications, we derive general principal components in such an affine-linear model, calibrate the model to government bond prices, and derive simple formulas to price caps and floors.

Keywords: Affine term-structure models, principal components, Heath-Jarrow-Morton, restricted exponential model, multi-factor Hull-White, G2

JEL Classification: E43, E47, G12, G13

Suggested Citation

Henseler, Michael and Peters, Christoph and Seydel, Roland C., A Tractable Multi-Factor Dynamic Term-Structure Model for Risk Management (February 23, 2017). Available at SSRN: https://ssrn.com/abstract=2225738 or http://dx.doi.org/10.2139/ssrn.2225738

Michael Henseler

German Finance Agency ( email )

Lurgiallee 5
Frankfurt/Main, 60439
Germany

Christoph Peters

German Finance Agency ( email )

Lurgiallee 5
Frankfurt/Main, 60439
Germany

Roland C. Seydel (Contact Author)

German Finance Agency ( email )

Lurgiallee 5
Frankfurt/Main, 60439
Germany

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