Kernel-Correlated Levy Field Driven Forward Rate and Application to Derivative Pricing

Abstract

We propose a term structure of forward rates driven by a kernel-correlated Levy random field under the HJM framework. The kernel-correlated Levy random field is composed of a kernel-correlated Gaussian random field and a centered Poisson random measure. We shall give a criterion to preclude arbitrage under the riskneutral pricing measure. As applications, an interest rate derivative with general payoff functional is priced under this pricing measure.

Keywords: Forward interest rate, Kernel-correlated L'evy field, HJM model, Derivative pricing

JEL Classification: C60