Scandinavian Working Papers in Economics
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The Economic Research Institute, Stockholm School of Economics SSE/EFI Working Paper Series in Economics and Finance

No 143:
Towards a General Theory of Bond Markets.

Tomas Björk (), Giovanni di Masi, Yuri Kabanov and Wolfgang Runggaldier

Abstract: The main purpose of the paper is to provide a mathematical background for the theory of bond markets similar to that available for stock markets. We suggest two constructions of stochastic integrals with respect to processes taking values in a space of continuous functions. Such integrals are used to define the evolution of the value of a portfolio of bonds corresponding to a trading strategy which is a measure- valued predictable process. The existence of an equivalent martingale measure is discussed and HJM-type conditions are derived for a jump-diffusion model. The question of market completeness is considered as a problem of the range of a certain integral operator. We introduce a concept of approximate market completeness and show that a market is approximately complete if an equivalent martingale measure is unique.

Keywords: Bond market; term structure of interest rates; stochastic integral; Banach space-valued integrators; measure-valued portfolio; jump-diffusion model; martingale measure; arbitrage; market completeness; (follow links to similar papers)

JEL-Codes: G12; G13; (follow links to similar papers)

33 pages, December 1996

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This paper is published as:
Björk, Tomas, Giovanni di Masi, Yuri Kabanov and Wolfgang Runggaldier, (1997), 'Towards a General Theory of Bond Markets.', Finance and Stochastics, Vol. 1, pages 141-174

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