Bond Indifference Prices

Quantitative Finance, Forthcoming

23 Pages Posted: 19 Jan 2021

See all articles by Matthew Lorig

Matthew Lorig

University of Washington - Applied Mathematics

Bin Zou

University of Connecticut - Department of Mathematics

Date Written: December 11, 2020

Abstract

In a market with stochastic interest rates, we consider an investor who can either (i) invest all of his wealth in a money market account or (ii) purchase zero-coupon bonds and invest the remainder of his wealth in the money market account. The indifference price of the zero-coupon bond is the price at which the investor could achieve the same expected utility under both strategies. In an affine term structure setting, we show that the indifference price of the zero-coupon bond is the root of an integral equation, when the investor's utility function is of exponential or power form. As an example, we compute the indifference price and the corresponding indifference yield curve in the Vasicek model and conduct sensitivity analysis to study the impact of various parameters on the yield curve. Furthermore, we discuss the choice of numeraire and its impact on the indifference prices.

Keywords: Bond, Pricing, Risk Neutral, Stochastic Interest, Yield

JEL Classification: G12, G13

Suggested Citation

Lorig, Matthew and Zou, Bin, Bond Indifference Prices (December 11, 2020). Quantitative Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3747288 or http://dx.doi.org/10.2139/ssrn.3747288

Matthew Lorig

University of Washington - Applied Mathematics ( email )

Seattle, WA
United States

Bin Zou (Contact Author)

University of Connecticut - Department of Mathematics ( email )

341 Mansfield Road U1009
Department of Mathematics
Storrs, CT 06269-1069
United States

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