Discount Models

Abstract

Discount is the difference between the face value of a bond and its present value. I propose an arbitrage-free dynamic framework for discount models, which provides an alternative to the Heath–Jarrow–Morton framework for forward rates. I derive general consistency conditions for factor models, and discuss affine term structure models in particular. There are several open problems, and I outline possible directions for further research.

Keywords: discount, factor models, stochastic partial differential equation, term structure models, zero-coupon bonds

JEL Classification: C32, G12, G13