Fundamental Properties of Bond Prices in Models of the Short-Term Rate

62 Pages Posted: 13 Oct 2001

See all articles by Antonio Mele

Antonio Mele

USI Università della Svizzera italiana; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)

Date Written: June 2002

Abstract

This paper develops restrictions that arbitrage-constrained bond prices impose on the short-term rate process in order to be consistent with given dynamic properties of the term-structure of interest rates. The central focus is the relationship between bond prices and the short-term rate volatility. In both scalar and multidimensional diffusion settings, typical relationships between bond prices and volatility are generated by joint restrictions on the risk-neutralized drift functions of the state variables and convexity of bond prices with respect to the short-term rate. The theory is illustrated by several examples and is partially extended to accommodate the occurrence of jumps and default.

Suggested Citation

Mele, Antonio, Fundamental Properties of Bond Prices in Models of the Short-Term Rate (June 2002). AFA 2002 Atlanta Meetings, U of London Queen Mary Economics Working Paper No. 460. Available at SSRN: https://ssrn.com/abstract=287099 or http://dx.doi.org/10.2139/ssrn.287099

Antonio Mele (Contact Author)

USI Università della Svizzera italiana ( email )

Via Buffi 13
Lugano, 6900
Switzerland

HOME PAGE: http://antoniomele.org

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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