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The Term Structure of Interest Rates as a Random Field

Robert S. Goldstein1,2

1 The Ohio State University · 2 State Library of Ohio

Review of Financial Studies 2000

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.

DOI
10.1093/rfs/13.2.365
Volume
13 (2)
Pages
365-384
Language
en
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