Lévy-Vasicek models and the long-bond return process

DOI10.1142/S0219024918500267zbMATH Open1398.91623arXiv1608.06376OpenAlexW3101034097MaRDI QIDQ4565077FDOQ4565077

Authors: Dorje C. Brody, Lane P. Hughston, D. M. Meier 

Publication date: 7 June 2018

Published in: International Journal of Theoretical and Applied Finance (Search for Journal in Brave)

Abstract: The classical derivation of the well-known Vasicek model for interest rates is reformulated in terms of the associated pricing kernel. An advantage of the pricing kernel method is that it allows one to generalize the construction to the L'evy-Vasicek case, avoiding issues of market incompleteness. In the L'evy-Vasicek model the short rate is taken in the real-world measure to be a mean-reverting process with a general one-dimensional L'evy driver admitting exponential moments. Expressions are obtained for the L'evy-Vasicek bond prices and interest rates, along with a formula for the return on a unit investment in the long bond, defined by $L_t=li{m}_{Tightarrowinfty}{P}_{tT}/P_{0T}$, where $P_{tT}$ is the price at time $t$ of a $T$-maturity discount bond. We show that the pricing kernel of a L'evy-Vasicek model is uniformly integrable if and only if the long rate of interest is strictly positive.

Full work available at URL: https://arxiv.org/abs/1608.06376

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zbMATH Keywords

long-term investmentVasicek modelpricing kernelslong bondinterest-rate modelsRoss recoveryLévy modelslong rate of interest

Mathematics Subject Classification ID

Processes with independent increments; Lévy processes (60G51) Interest rates, asset pricing, etc. (stochastic models) (91G30)

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Cited In (4)

• BEHAVIOR OF LONG-TERM YIELDS IN A LÉVY TERM STRUCTURE
• STATE SPACE DECOMPOSITION AND CLASSIFICATION OF TERM STRUCTURE SHAPES IN THE TWO-FACTOR VASICEK MODEL
• Lévy-Ito models in finance
• On modelling long term stock returns with ergodic diffusion processes: arbitrage and arbitrage-free specifications

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