Markov-Functional Interest Rate Models

25 Pages Posted: 12 Jan 1998  

Phil J. Hunt

Citigroup - Global Corporate and Investment Banking Group (GCIB)

Joanne Kennedy

University of Warwick - Department of Statistics

Antoon Pelsser

Maastricht University; Netspar

Multiple version iconThere are 2 versions of this paper

Date Written: October 5, 1999

Abstract

We introduce a general class of interest rate models in which the value of pure discount bonds can be expressed as a functional of some (low-dimensional) Markov process. At the abstract level this class includes all current models of practical importance. By specifying these models in Markov-functional form, we obtain a specification which is efficient to implement. An additional advantage of Markov-functional models is the fact that the specification of the model can be such that the forward rate distribution implied by market option prices can be fitted exactly, which makes these models particularly suited for derivatives pricing. We give examples of Markov-functional models that are fitted to market prices of caps/floors and swaptions.

JEL Classification: G13

Suggested Citation

Hunt, Phil J. and Kennedy, Joanne and Pelsser, Antoon, Markov-Functional Interest Rate Models (October 5, 1999). Available at SSRN: https://ssrn.com/abstract=49240 or http://dx.doi.org/10.2139/ssrn.49240

Phil James Hunt

Citigroup - Global Corporate and Investment Banking Group (GCIB) ( email )

Citigroup Centre
Canada Square, Canary Wharf
London, E14 5LB
United Kingdom

Joanne E. Kennedy

University of Warwick - Department of Statistics ( email )

Coventry CV4 7AL
United Kingdom

Antoon A. J. Pelsser (Contact Author)

Maastricht University ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands

HOME PAGE: http://https://sites.google.com/site/apelsseraca/

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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