Bond Pricing Formulas for Markov-modulated Affine Term Structure Models
Journal of Industrial and Management Optimization
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.
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Natural Sciences and Engineering Research Council of Canada