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A Yield‐Factor Model Of Interest Rates

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  • Darrell Duffie
  • Rui Kan

Abstract

This paper presents a consistent and arbitrage‐free multifactor model of the term structure of interest rates in which yields at selected fixed maturities follow a parametric muitivariate Markov diffusion process with “stochastic volatility.” the yield of any zero‐coupon bond is taken to be a maturity‐dependent affine combination of the selected “basis” set of yields. We provide necessary and sufficient conditions on the stochastic model for this affine representation. We include numerical techniques for solving the model, as well as numerical techniques for calculating the prices of term‐structure derivative prices. the case of jump diffusions is also considered.

Suggested Citation

  • Darrell Duffie & Rui Kan, 1996. "A Yield‐Factor Model Of Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(4), pages 379-406, October.
    • Handle: RePEc:bla:mathfi:v:6:y:1996:i:4:p:379-406
    DOI: 10.1111/j.1467-9965.1996.tb00123.x
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