In this section, we start from a simple multi-factor HJM term structure model and derive the drift term of the forward rate dynamics required to obtain an arbitrage-free model framework (see HJM [35]). Furthermore, we derive the equivalence between the HJM-framework and a corresponding extended short rate model. Then, by applying our option pricing technique (see chapter (2)) we are able derive the well known closed-form solution for the price of an option on a discount bond (e.g. caplet or floorlet).
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© 2008 Springer-Verlag Berlin Heidelberg
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(2008). Multi-Factor HJM models. In: Pricing of Bond Options. Lecture Notes in Economics and Mathematical Systems, vol 615. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-540-70729-5_5
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DOI: https://doi.org/10.1007/978-3-540-70729-5_5
Publisher Name: Springer, Berlin, Heidelberg
Print ISBN: 978-3-540-70721-9
Online ISBN: 978-3-540-70729-5
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