Interest rates risk-premium and shape of the yield curve

Srdjan  Stojanovic

doi:10.3934/dcdsb.2016013

Article Contents

2016, Volume 21, Issue 5: 1603-1615. Doi: 10.3934/dcdsb.2016013

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Interest rates risk-premium and shape of the yield curve

Srdjan Stojanovic^1,

1.
Department of Mathematical Sciences, University of Cincinnati, Cincinnati, Ohio 45221-0025

Received: March 31, 2015

Revised: November 30, 2015

Published: June 2016

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Abstract

We apply the general theory of pricing in incomplete markets, due to the author, on the problem of pricing bonds for the Hull-White stochastic interest rate model. As pricing in incomplete markets involves more market parameters than the classical theory, and as the derived risk premium is time-dependent, the proposed methodology might offer a better way for replicating different shapes of the empirically observed yield curves. For example, the so-called humped yield curve can be obtained from a normal yield curve by only increasing the investors risk aversion.

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Mathematics Subject Classification: Primary: 60H10, 60G40, 93E20.

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