Bond Pricing Formulas for Markov-modulated Affine Term Structure Models
Publication Name
Journal of Industrial and Management Optimization
Abstract
This article provides new developments in characterizing the class of regime-switching exponential affine interest rate processes in the context of pricing a zero-coupon bond. A finite-state Markov chain in continuous time dictates the random switching of time-dependent parameters of such processes. We present exact and approximate bond pricing formulas by solving a system of partial differential equations and minimizing an error functional. The bond price expression exhibits a representation that shows how it is explicitly im-pacted by the rate matrix and the time-dependent coefficient functions of the short rate models. We validate the bond pricing formulas numerically by ex-amining a regime-switching Vasicek model.
Open Access Status
This publication may be available as open access
Volume
17
Issue
5
First Page
2685
Last Page
2702
Funding Number
RGPIN-2017-04235
Funding Sponsor
Natural Sciences and Engineering Research Council of Canada