A Theory of the Term Structure with an Official Short Rate

Financial Options Research Centre Working Paper No. 94/49, May 1994

Posted: 10 Oct 1998

See all articles by Simon H. Babbs

Simon H. Babbs

The Options Clearing Corporation

Nick Webber

University of Warwick - Warwick Business School

Abstract

Many of the larger movements in market interest rates are associated with changes in official interest rate policy. This applies especially in the UK, where the Bank of England effectively controls very short term rates and moves its key dealing rate in multiples of a discrete unit. We present a theory of the term structure, with the short rate following a pure jump process with stochastic intensities depending on the short rate and a diffusion state variable. An illustrative model mimics empirical regularities of UK rates. We suggest how to extend our approach to other countries, most readily the US.

JEL Classification: E43, G15

Suggested Citation

Babbs, Simon H. and Webber, Nick, A Theory of the Term Structure with an Official Short Rate. Financial Options Research Centre Working Paper No. 94/49, May 1994, Available at SSRN: https://ssrn.com/abstract=6297

Simon H. Babbs

The Options Clearing Corporation ( email )

1 N. Wacker Drive
Chicago, IL 60606
United States
312 322 6288 (Phone)
312 322 4442 (Fax)

Nick Webber (Contact Author)

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom
+(44) 24 7652 4664 (Phone)

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