Boundary conditions for the single-factor term structure equation

DOI10.1214/10-AAP698zbMATH Open1232.91679arXiv1101.1149MaRDI QIDQ627249FDOQ627249

Authors: Erik Ekström, Johan Tysk 

Publication date: 21 February 2011

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

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.

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

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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)

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• BENCHOP -- SLV: the BENCHmarking project in option pricing -- stochastic and local volatility problems

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