THE TERM STRUCTURE OF INTEREST RATES AS A GAUSSIAN RANDOM FIELD |
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| Authors: | D P Kennedy |
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| Institution: | Statistical Laboratory, University of Cambridge, Cambridge, UK |
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| Abstract: | A simple model of the term structure of interest rates is introduced in which the family of instantaneous forward rates evolves as a continuous Gaussian random field. A necessary and sufficient condition for the associated family of discounted zero-coupon bond prices to be martingales is given, permitting the consistent pricing of interest rate contingent claims. Examples of the pricing of interest-rate caps and the situation when the Gaussian random field may be viewed as a deterministic time change of the standard Brownian sheet are discussed. |
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| Keywords: | term structure bond prices martingale measure Contingent claims interest-rate caps hedging strategies Gaussian random field |
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