To read the full version of this content please select one of the options below:

Bond valuation under a discrete‐time regime‐switching term‐structure model and its continuous‐time extension

Robert J. Elliott (Haskayne School of Business, University of Calgary, Calgary, Canada and School of Mathematical Sciences, University of Adelaide, Adelaide, Australia)
Tak Kuen Siu (Department of Actuarial Studies and Centre of Financial Risk, Faculty of Business and Economics, Macquarie University, Sydney, Australia)
Alex Badescu (Department of Mathematics and Statistics, University of Calgary, Calgary, Canada)

Managerial Finance

ISSN: 0307-4358

Article publication date: 27 September 2011

Abstract

Purpose

The purpose of this paper is to consider a discrete‐time, Markov, regime‐switching, affine term‐structure model for valuing bonds and other interest rate securities. The proposed model incorporates the impact of structural changes in (macro)‐economic conditions on interest‐rate dynamics. The market in the proposed model is, in general, incomplete. A modified version of the Esscher transform, namely, a double Esscher transform, is used to specify a price kernel so that both market and economic risks are taken into account.

Design/methodology/approach

The market in the proposed model is, in general, incomplete. A modified version of the Esscher transform, namely, a double Esscher transform, is used to specify a price kernel so that both market and economic risks are taken into account.

Findings

The authors derive a simple way to give exponential affine forms of bond prices using backward induction. The authors also consider a continuous‐time extension of the model and derive exponential affine forms of bond prices using the concept of stochastic flows.

Originality/value

The methods and results presented in the paper are new.

Keywords

Citation

Elliott, R.J., Kuen Siu, T. and Badescu, A. (2011), "Bond valuation under a discrete‐time regime‐switching term‐structure model and its continuous‐time extension", Managerial Finance, Vol. 37 No. 11, pp. 1025-1047. https://doi.org/10.1108/03074351111167929

Publisher

:

Emerald Group Publishing Limited

Copyright © 2011, Emerald Group Publishing Limited