SSE/EFI Working Paper Series in Economics and Finance
A Geometric View of Interest Rate Theory
Abstract: The purpose of this essay is to give an overview of some
recent workconcerning structural properties of the evolution of the forward
rate curve in an arbitrage free bond market. The main problems to be
discussed are as follows.
1. When is a given forward rate model
consistent with a given family of forward rate curves?
2. When can
the inherently infinite dimensional forward rate process be realized by
means of a finite dimensional state space model.
interest rate models of Heath-Jarrow-Morton type, where the forward rates
are driven by a multi- dimensional Wiener process, and where he volatility
is allowed to be an arbitrary smooth functional of the present forward rate
curve. Within this framwork we give necessary and sufficient conditions for
consistency, as well as for the existence of a finite dimensional
realization, in terms of the forward rate volatilities.
Keywords: interest rates; Markovian realizations; forward rates; invariant manifold; (follow links to similar papers)
JEL-Codes: E43; G13; (follow links to similar papers)
39 pages, December 20, 2000, Revised December 21, 2000
To appear in "Handbook of Mathematical Finance". Cambridge University Press
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Full text versions of the paper:
- This paper is published as:
Björk, Tomas, (2001), 'A Geometric View of Interest Rate Theory' in Jouini, Elyes, Jaksa Cvitanic and Marek Musiela (eds.) Option pricing, Interest Rates and Risk Management, Handbooks in Mathematical Finance, chapter 7, pages 241-277, Cambridge University Press, ISBN 0 521 79237 1.
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