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Bond Pricing under Knightian Uncertainty. A Short Rate Model with Drift and Volatility Uncertainty

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  • Hölzermann, Julian

    (Center for Mathematical Economics, Bielefeld University)

Abstract

It is shown how to construct an arbitrage-free short rate model under uncertainty about the drift and the volatility. The uncertainty is represented by a set of priors, which naturally leads to a G-Brownian motion. Within this framework, it is shown how to characterize the whole term structure without admitting arbitrage. The pricing of zero-coupon bonds in such a setting differs substantially from the traditional models, since the prices need to be chosen in a different way in order to exclude arbitrage.

Suggested Citation

  • Hölzermann, Julian, 2018. "Bond Pricing under Knightian Uncertainty. A Short Rate Model with Drift and Volatility Uncertainty," Center for Mathematical Economics Working Papers 582, Center for Mathematical Economics, Bielefeld University.
    • Handle: RePEc:bie:wpaper:582
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    File URL: https://pub.uni-bielefeld.de/download/2930378/2930379
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    References listed on IDEAS

    as
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