Boundary conditions for the single-factor term structure equation

DOI10.1214/10-AAP698MaRDI QIDQ627249zbMATH OpenFDO

Authors Erik Ekström, Johan Tysk

Publication date 21 February 2011

Published in The Annals of Applied Probability (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1101.1149

zbMATH Keywords

degenerate parabolic equationsstochastic representationthe term structure equation

Mathematics Subject Classification ID

Diffusion processes (60J60) Uniqueness problems for PDEs: global uniqueness, local uniqueness, non-uniqueness (35A02) Degenerate parabolic equations (35K65) Interest rates, asset pricing, etc. (stochastic models) (91G30)

Abstract: We study the term structure equation for single-factor models that predict nonnegative short rates. In particular, we show that the price of a bond or a bond option is the unique classical solution to a parabolic differential equation with a certain boundary behavior for vanishing values of the short rate. If the boundary is attainable then this boundary behavior serves as a boundary condition and guarantees uniqueness of solutions. On the other hand, if the boundary is nonattainable then the boundary behavior is not needed to guarantee uniqueness but it is nevertheless very useful, for instance, from a numerical perspective.

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• Boundary conditions for computing densities in hybrid models via PDE methods
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• Minimal Root's embeddings for general starting and target distributions

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