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The Potential Approach to Bond and Currency Pricing

Author

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  • Markus Leippold

    (University of St.Gallen)

  • Liuren Wu

    (Fordham University New York)

Abstract

In this paper, we begin the modeling of bond and currency prices from the modeling of the state-price density satisfying basic properties of a potential. We provide extensive examples and show their implications on bond and currency pricing. Most classic short rate models are special cases of this general approach. We also investigate the connection to the Heath, Jarrow, and Morton model. One advantage of the potential approach resides in its ease in simultaneously modeling the yield curves of many countries and their exchange rates. The properties of exchange rates under each example are derived and we illustrate their possibility in explaining the forward premium puzzle.

Suggested Citation

  • Markus Leippold & Liuren Wu, 1999. "The Potential Approach to Bond and Currency Pricing," Finance 9903004, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpfi:9903004
    Note: Type of Document - LaTex; prepared on IBM PC - PC-TEX; to print on HP/PostScript; pages: 50; figures: none. none
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    References listed on IDEAS

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    Cited by:

    1. Leippold, Markus & Wu, Liuren, 2002. "Asset Pricing under the Quadratic Class," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(2), pages 271-295, June.
    2. Gibson, Rajna & Lhabitant, Francois-Serge & Talay, Denis, 2010. "Modeling the Term Structure of Interest Rates: A Review of the Literature," Foundations and Trends(R) in Finance, now publishers, vol. 5(1–2), pages 1-156, December.
    3. Markus Leippold & Liuren Wu, 2003. "Design and Estimation of Quadratic Term Structure Models," Review of Finance, European Finance Association, vol. 7(1), pages 47-73.

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    More about this item

    Keywords

    Potential approach; Interest Rate; Currency; International Term Structure Models; Heath-Jarrow-Morton; Forward Premium Puzzle;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General

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