The term structure of interest rates as a random field

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Abstract

Forward rate dynamics are modeled as a random field. In contrast to multifactor models, random field models offer a parsimonious description of term structure dynamics, while eliminating the self-inconsistent practice of recalibration. The form of the drift of the instantaneous forward rate process necessary to preclude arbitrage under the risk-neutral measure is obtained. Forward risk-adjusted measures are identified and used to price a bond option when the forward volatility structure depends on the square root of the current spot rate. Several classes of tractable random field models are presented.

Original languageEnglish (US)
Pages (from-to)365-384
Number of pages20
JournalReview of Financial Studies
Volume13
Issue number2
DOIs
StatePublished - Jan 1 2000

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