A general characterization of one factor affine term structure models (Q5950467)

This paper deals with the characterization of the class of all non-negative Markov short rate processes \(r\) which yield an affine term structure. For any time homogeneous progressively measurable Markov process \(r\) on \(\mathbb{R}_{+}\), which satisfies the condition \(\int_{0}^{t}r_{s} ds<\infty\) a.s. for all \(t\), assuming affine term structure, the authors show, using Markov semigroup theory, that \(r\) is necessarily a Feller process with the generator \[ Af(x)=\alpha xf''(x)+(b'+\beta x)f'(x)+ \int_{\mathbb{R}_{+}}^{0} (f(x+y)-f(x)-f'(x)(1\wedge y))(m(dy)+x\mu(dy)). \] Such processes are known as conservative CBI-processes (continuous state branching processes with immigration). The authors establish a one-to-one correspondence between the class of conservative CBI-processes and Markov short rate processes implying an affine term structure. Using the pricing semigroup \[ Q_{t}f(x)={\mathbf E} \left[ \exp\Biggl\{-\int_{0}^{t}r_{s} ds\Biggr\} f(r_{t})|r_0=x\right], \] the authors obtain closed form expressions for all European claims \(f(r_{t})\). The non-continuous short rate model which extends the classical CIR model is considered and closed form expressions for European bond option prices are given. In the multifactor case, however, affine term structure does not longer imply affinity of the underlying Markovian factors. The corresponding counter example is presented.