1. A positive interest rate model with sticky barrier.
- Author
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Kabanov, Yuri, Kijima, Masaaki, and Rinaz, Sofiane
- Subjects
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INTEREST rates , *FINITE differences , *INTEGRO-differential equations , *BOND prices , *RATE of return , *LIBOR - Abstract
This paper proposes an efficient model for the term structure of interest rates when the interest rate takes very small values. We make the following choices: (i) we model the short-term interest rate, (ii) we assume that once the interest rate reaches zero, it stays there and we have to wait for a random time until the rate is reinitialized to a (possibly random) strictly positive value. This setting ensures that all term rates are strictly positive. Our objective is to provide a simple method to price zero-coupon bonds. A basic statistical study of the data at hand indeed suggests a switch to a different mode of behaviour when we get to a low level of interest rates. We introduce a variable for the time already spent at 0 (during the last stay) and derive the pricing equation for the bond. We then solve this partial integro-differential equation (PIDE) on its entire domain using a finite difference method (Cranck-Nicholson scheme), a method of characteristics and a fixed point algorithm. Resulting yield curves can exhibit many different shapes, including the S shape observed on the recent Japanese market. [ABSTRACT FROM AUTHOR]
- Published
- 2007
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