A Simple Regime Switching Term Structure Model

Posted: 29 Jan 2001

See all articles by Asbjorn T. Hansen

Asbjorn T. Hansen

Dresdner Kleinwort Benson; Aarhus University

Rolf Poulsen

University of Copenhagen - Department of Statistics and Operations Research

Abstract

We extend the short rate model of Vasicek (1977) to include jumps in the local mean. Conditions ensuring existence of a unique equivalent martingale measure are given, implying that the model is arbitrage-free and complete. We develop efficient numerical methods for computation of zero coupon bond prices, illustrate how the model is easily calibrated to market data and show how other interest rate derivatives can be priced.

Keywords: Regime switching, term structure of interest rates, numerical methods, option pricing

JEL Classification: C15, C63, E43, G13

Suggested Citation

Hansen, Asbjorn T. and Poulsen, Rolf, A Simple Regime Switching Term Structure Model. Finance and Stochastics, Vol. 4, Issue 4. Available at SSRN: https://ssrn.com/abstract=239358

Asbjorn T. Hansen

Dresdner Kleinwort Benson

20 Fenchurch Street
London EC3P 3DB
United Kingdom

Aarhus University ( email )

Dept. of Operations Research
DK-8000 Aarhus C
Denmark

Rolf Poulsen (Contact Author)

University of Copenhagen - Department of Statistics and Operations Research ( email )

Universitetsparken 5
DK-2100
Denmark
+45 (353) 20685 (Phone)

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