We develop a tractable and flexible stochastic volatility multi-factor model of the term structure of interest rates. It features correlations between innovations to forward rates and volatilities, quasi-analytical prices of zero-coupon bond options and dynamics of the forward rate curve, under...

Most affine models of the term structure with stochastic volatility (SV) predict that the variance of the short rate is simultaneously a linear combination of yields and the quadratic variation of the spot rate. However, we find empirically that the A1(3) SV model generates a time series for the...

This paper describes a class of stochastic stabilizing policies within asset price regimes that can be easily incorporated into the framework of regime switching recently proposed by Froot and Obstfeld (1991). In contrast to previous treatments of market-driven fundamentals within the regime,...

Regime-switching models are well suited to capture the non-linearities in interest rates. This paper examines the econometric performance of regime-switching models for interest rate data from the US, Germany and the UK. There is strong evidence supporting the presence of regime switches but...

Mathematical models of bond pricing are used by both academics and Wall Street practitioners, with practitioners introducing time-dependent parameters to fit arbitrage-free models to selected asset prices. We show, in a simple one-factor setting, that the ability of such models to reproduce a...

This paper presents an equilibrium model of the term structure of interest rates when investors have heterogeneous preferences. The basic model considers a pure exchange economy of two classes of investors with different (but constant) relative risk-aversion and gives closed-form solutions to...

By applying stochastic dominance arguments, upper bounds on the reservation write price of European calls and puts and lower bounds on the reservation purchase price of these derivatives are derived in the presence of proportional transaction costs incurred in trading the underlying security....

Given a European derivative security with an arbitrary payoff function and a corresponding set of" underlying securities on which the derivative security is based, we solve the dynamic replication problem: find a" self-financing dynamic portfolio strategy involving only the underlying securities...

An efficient method is developed for pricing American options on combination stochastic volatility/jump-diffusion processes when jump risk and volatility risk are systematic and nondiversifiable, thereby nesting two major option pricing models. The parameters implicit in PHLX-traded Deutschemark...

Contrary to the Black-Scholes model, volatilities implied by index option prices depend on the exercise price of the option and are often higher than realized volatilities. We explain both facts in the context of a model that can also explain the mean and volatility of equity returns. Our model...