Natalia A.Beliaeva, PhD, is an Assistant Professor of Finance at the Sawyer Business School, Suffolk University, Boston. She also holds a master's degree in computer science (artificial intelligence) from the University of Massachusetts Amherst. Dr. Beliaeva's expertise is in the area of applied numerical methods for pricing fixed income derivatives.
Gloria M.Soto, PhD, is a Professor of Applied Economics and Finance at the University of Murcia, Spain, where she teaches courses in financial markets and institutions and applied economics. Dr. Soto has published extensively in both Spanish and international journals in finance and economics, especially in the areas of interest rate risk management and related fixed income topics.
List of Figures | p. xxxi |
List of Tables | p. xxxv |
A Simple Introduction to Continuous-Time Stochastic Processes | p. 1 |
Continuous-Time Diffusion Processes | p. 3 |
Wiener Process | p. 3 |
Ito Process | p. 5 |
Ito's Lemma | p. 7 |
Simple Rules of Stochastic Differentiation and Integration | p. 9 |
Obtaining Unconditional Mean and Variance of Stochastic Integrals under Gaussian Processes | p. 9 |
Examples of Gaussian Stochastic Integrals | p. 11 |
Mixed Jump-Diffusion Processes | p. 14 |
The Jump-Diffusion Process | p. 14 |
Ito's Lemma for the Jump-Diffusion Process | p. 15 |
Arbitrage-Free Valuation | p. 17 |
Arbitrage-Free Valuation: Some Basic Results | p. 18 |
A Simple Relationship between Zero-Coupon Bond Prices and Arrow Debreu Prices | p. 20 |
The Bayes Rule for Conditional Probabilities of Events | p. 20 |
The Relationship between Current and Future AD Prices | p. 21 |
The Relationship between Cross-Sectional AD Prices and Intertemporal Term Structure Dynamics | p. 22 |
Existence of the Risk-Neutral Probability Measure | p. 23 |
Stochastic Discount Factor | p. 28 |
Radon-Nikodym Derivative | p. 30 |
Arbitrage-Free Valuation in Continuous Time | p. 31 |
Change of Probability Measure under a Continuous Probability Density | p. 32 |
The Girsanov Theorem and the Radon-Nikodym Derivative | p. 34 |
Equivalent Martingale Measures | p. 35 |
Stochastic Discount Factor and Risk Premiums | p. 43 |
The Feynman-Kac Theorem | p. 43 |
Valuing Interest Rate and Credit Derivatives: Basic Pricing Frameworks | p. 49 |
Eurodollar and Other Time Deposit Futures | p. 54 |
Valuing Futures on a Time Deposit | p. 58 |
Convexity Bias | p. 60 |
Treasury Bill Futures | p. 61 |
Valuing T-Bill Futures | p. 62 |
Convexity Bias | p. 63 |
Treasury Bond Futures | p. 64 |
Conversion Factor | p. 65 |
Cheapest-to-Deliver Bond | p. 67 |
Options Embedded in T-Bond Futures | p. 68 |
Valuing T-Bond Futures | p. 68 |
Treasury Note Futures | p. 72 |
Forward Rate Agreements | p. 73 |
Interest Rate Swaps | p. 74 |
Day-Count Conventions | p. 76 |
The Financial Intermediary | p. 77 |
Motivations for Interest Rate Swaps | p. 78 |
Pricing Interest Rate Swaps | p. 82 |
Interest Rate Swaptions | p. 85 |
Caps and Floors | p. 88 |
Caplet | p. 90 |
Floorlet | p. 91 |
Collarlet | p. 92 |
Caps, Floors, and Collars | p. 92 |
Black Implied Volatilities for Caps and Swaptions | p. 93 |
Black Implied Volatilities: Swaptions | p. 95 |
Black Implied Volatilities: Caplet | p. 96 |
Black Implied Volatilities: Caps | p. 97 |
Black Implied Volatilities: Difference Caps | p. 98 |
Pricing Credit Derivatives Using the Reduced-Form Approach | p. 98 |
Default Intensity and Survival Probability | p. 100 |
Recovery Assumptions | p. 101 |
Risk-Neutral Valuation under the RMV Assumption | p. 102 |
Risk-Neutral Valuation under the RFV Assumption | p. 103 |
Valuing Credit Default Swaps Using the RFV Assumption | p. 104 |
A New Taxonomy of Term Structure Models | p. 106 |
Fundamental and Preference-Free Single-Factor Gaussian Models | p. 113 |
The Arbitrage-Free Pricing Framework of Vasicek | p. 115 |
The Term Structure Equation | p. 116 |
Risk-Neutral Valuation | p. 118 |
The Fundamental Vasicek Model | p. 120 |
Bond Price Solution | p. 124 |
Preference-Free Vasicek+, Vasicek++, and Vasicek+++ Models | p. 128 |
The Vasicek+ Model | p. 128 |
The Vasicek++, or the Extended Vasicek Model | p. 136 |
The Vasicek+++, or the Fully Extended Vasicek Model | p. 140 |
Valuing Futures | p. 144 |
Valuing Futures under the Vasicek, Vasicek+ and Vasicek++ Models | p. 145 |
Valuing Futures under the Vasicek+++ Model | p. 150 |
Valuing Options | p. 153 |
Options on Zero-Coupon Bonds | p. 153 |
Options on Coupon Bonds | p. 157 |
Valuing Interest Rate Contingent Claims Using Trees | p. 161 |
Binomial Trees | p. 163 |
Trinomial Trees | p. 165 |
Trinomial Tree under the Vasicek++ Model: An Example | p. 171 |
Trinomial Tree under the Vasicek+++ Model: An Example | p. 178 |
Bond Price Solution Using the Risk-Neutral Valuation Approach under the Fundamental Vasicek Model and the Preference-Free Vasicek+ Model | p. 181 |
Hull's Approximation to Convexity Bias under the Ho and Lee Model | p. 184 |
Fundamental and Preference-Free Jump-Extended Gaussian Models | p. 187 |
Fundamental Vasicek-GJ Model | p. 188 |
Bond Price Solution | p. 191 |
Jump-Diffusion Tree | p. 194 |
Preference-Free Vasicek-GJ+ and Vasicek-GJ++ Models | p. 201 |
The Vasicek-GJ+ Model | p. 202 |
The Vasicek-GJ++ Model | p. 203 |
Jump-Diffusion Tree | p. 205 |
Fundamental Vasicek-EJ Model | p. 206 |
Bond Price Solution | p. 207 |
Jump-Diffusion Tree | p. 209 |
Preference-Free Vasicek-EJ++ Model | p. 216 |
Jump-Diffusion Tree | p. 218 |
Valuing Futures and Options | p. 218 |
Valuing Futures | p. 219 |
Valuing Options: The Fourier Inversion Method | p. 222 |
Probability Transformations with a Damping Constant | p. 233 |
The Fundamental Cox, Ingersoll, and Ross Model with Exponential and Lognormal Jumps | p. 237 |
The Fundamental Cox, Ingersoll, and Ross Model | p. 239 |
Solution to Riccati Equation with Constant Coefficients | p. 242 |
CIR Bond Price Solution | p. 243 |
General Specifications of Market Prices of Risk | p. 244 |
Valuing Futures | p. 245 |
Valuing Options | p. 248 |
Interest Rate Trees for the Cox, Ingersoll, and Ross Model | p. 250 |
Binomial Tree for the CIR Model | p. 250 |
Trinomial Tree for the CIR Model | p. 263 |
Pricing Bond Options and Interest Rate Options with Trinomial Trees | p. 273 |
The CIR Model Extended with Jumps | p. 279 |
Valuing Futures | p. 283 |
Futures on a Time Deposit | p. 284 |
Valuing Options | p. 285 |
Jump-Diffusion Trees for the CIR Model Extended with Jumps | p. 287 |
Exponential Jumps | p. 287 |
Lognormal Jumps | p. 295 |
Preference-Free CIR and CEV Models with Jumps | p. 305 |
Mean-Calibrated CIR Model | p. 307 |
Preference-Free CIR+ and CIR++ Models | p. 309 |
A Common Notational Framework | p. 312 |
Probability Density and the Unconditional Moments | p. 313 |
Bond Price Solution | p. 315 |
Expected Bond Returns | p. 317 |
Constant Infinite-Maturity Forward Rate under Explosive CIR+ and CIR++ Models | p. 318 |
A Comparison with Other Markovian Preference-Free Models | p. 321 |
Calibration to the Market Prices of Bonds and Interest Rate Derivatives | p. 322 |
Valuing Futures | p. 323 |
Valuing Options | p. 325 |
Interest Rate Trees | p. 327 |
The CIR+ and CIR++ Models Extended with Jumps | p. 328 |
Preference-Free CIR-EJ+ and CIR-EJ++ Models | p. 329 |
Jump-Diffusion Trees | p. 331 |
Fundamental and Preference-Free Constant-Elasticity-of-Variance Models | p. 331 |
Forward Rate and Bond Return Volatilities under the CEV++ Models | p. 333 |
Valuing Interest Rate Derivatives Using Trinomial Trees | p. 336 |
Fundamental and Preference-Free Constant-Elasticity-of-Variance Models with Lognormal Jumps | p. 341 |
Fundamental and Preference-Free Two-Factor Affine Models | p. 345 |
Two-Factor Gaussian Models | p. 348 |
The Canonical, or the Ac, Form: The Dai and Singleton [2002] Approach | p. 349 |
The Ar Form: The Hull and White [1996] Approach | p. 353 |
The Ay Form: The Brigo and Mercuric [2001, 2006] Approach | p. 356 |
Relationship between the A[subscript 0c](2)++ Model and the A[subscript 0y](2)++ Model | p. 358 |
Relationship between the A[subscript 0r](2)++ Model and the A[subscript 0y](2)++ Model | p. 360 |
Bond Price Process and Forward Rate Process | p. 361 |
Probability Density of the Short Rate | p. 362 |
Valuing Options | p. 363 |
Two-Factor Gaussian Trees | p. 364 |
Two-Factor Hybrid Models | p. 373 |
Bond Price Process and Forward Rate Process | p. 377 |
Valuing Futures | p. 377 |
Valuing Options | p. 380 |
Two-Factor Stochastic Volatility Trees | p. 382 |
Two-Factor Square-Root Models | p. 393 |
The Ay Form | p. 393 |
The Ar Form | p. 399 |
Relationship between the Canonical Form and the Ar Form | p. 402 |
Two-Factor "Square-Root" Trees | p. 403 |
Hull and White Solution of [eta](t, T) | p. 410 |
Fundamental and Preference-Free Multifactor Affine Models | p. 413 |
Three-Factor Affine Term Structure Models | p. 416 |
The A[subscript 1r](3), A[subscript 1r](3)+, and A[subscript 1r](3)++ Models | p. 416 |
The A[subscript 2r](3), A[subscript 2r](3)+, and A[subscript 2r](3)++ Models | p. 421 |
Simple Multifactor Affine Models with Analytical Solutions | p. 425 |
The Simple A[subscript M](N) Models | p. 425 |
The Simple A[subscript M](N)+ and A[subscript M](N)++ Models | p. 427 |
The Nested ATSMs | p. 429 |
Valuing Futures | p. 429 |
Valuing Options on Zero-Coupon Bonds or Caplets: The Fourier Inversion Method | p. 433 |
Valuing Options on Coupon Bonds or Swaptions: The Cumulant Expansion Approximation | p. 435 |
Calibration to Interest Rate Caps Data | p. 448 |
Unspanned Stochastic Volatility | p. 455 |
Multifactor ATSMs for Pricing Credit Derivatives | p. 457 |
Simple Reduced-Form ATSMs under the RMV Assumption | p. 458 |
Simple Reduced-Form ATSMs under the RFV Assumption | p. 468 |
The Solution of [eta](t, T, [phiv]) for CDS Pricing Using Simple A[subscript M](N) Models under the RFV Assumption | p. 476 |
Stochastic Volatility Jump-Based Mixed-Sign A[subscript N](N)-EJ++ Model and A[subscript 1](3)-EJ++ Model | p. 477 |
The Mixed-Sign A[subscript N](N)-EJ++ Model | p. 478 |
The A[subscript 1](3)-EJ++Model | p. 479 |
Fundamental and Preference-Free Quadratic Models | p. 483 |
Single-Factor Quadratic Term Structure Model | p. 484 |
Duration and Convexity | p. 488 |
Preference-Free Single-Factor Quadratic Model | p. 492 |
Forward Rate Volatility | p. 495 |
Model Implementation Using Trees | p. 497 |
Extension to Jumps | p. 498 |
Fundamental Multifactor QTSMs | p. 501 |
Bond Price Formulas under Q[subscript 3](N) and Q[subscript 4](N) Models | p. 505 |
Parameter Estimates | p. 506 |
Preference-Free Multifactor QTSMs | p. 508 |
Forward Rate Volatility and Correlation Matrix | p. 515 |
Valuing Futures | p. 518 |
Valuing Options on Zero-Coupon Bonds or Caplets: The Fourier Inversion Method | p. 524 |
Valuing Options on Coupon Bonds or Swaptions: The Cumulant Expansion Approximation | p. 527 |
Calibration to Interest Rate Caps Data | p. 531 |
Multifactor QTSMs for Valuing Credit Derivatives | p. 537 |
Reduced-Form Q[subscript 3](N), Q[subscript 3](N)+, and Q[subscript 3](N)++ Models under the RMV Assumption | p. 537 |
Reduced-Form Q[subscript 3](N) and Q[subscript 3](N)+ Models under the RFV Assumption | p. 543 |
The Solution of [eta](t, T, [phiv]) for CDS Pricing Using the Q[subscript 3](N) Model under the RFV Assumption | p. 547 |
The HJM Forward Rate Model | p. 551 |
The HJM Forward Rate Model | p. 552 |
Numerical Implementation Using Nonrecombining Trees | p. 556 |
A One-Factor Nonrecombining Binomial Tree | p. 557 |
A Two-Factor Nonrecombining Trinomial Tree | p. 565 |
Recursive Programming | p. 569 |
A Recombining Tree for the Proportional Volatility HJM Model | p. 572 |
Forward Price Dynamics under the Forward Measure | p. 573 |
A Markovian Forward Price Process under the Proportional Volatility Model | p. 575 |
A Recombining Tree for the Proportional Volatility Model Using the Nelson and Ramaswamy Transform | p. 576 |
The LIBOR Market Model | p. 583 |
The Lognormal Forward LIBOR Model (LFM) | p. 585 |
Multifactor LFM under a Single Numeraire | p. 588 |
The Lognormal Forward Swap Model (LSM) | p. 591 |
A Joint Framework for Using Black's Formulas for Pricing Caps and Swaptions | p. 595 |
The Relationship between the Forward Swap Rate and Discrete Forward Rates | p. 596 |
Approximating the Black Implied Volatility of a Swaption under the LFM | p. 597 |
Specifying Volatilities and Correlations | p. 600 |
Forward Rate Volatilities: Some General Results | p. 600 |
Forward Rate Volatilities: Specific Functional Forms | p. 604 |
Instantaneous Correlations and Terminal Correlations | p. 608 |
Full-Rank Instantaneous Correlations | p. 612 |
Reduced-Rank Correlation Structures | p. 619 |
Terminal Correlations | p. 623 |
Explaining the Smile: The First Approach | p. 623 |
The CEV Extension of the LFM | p. 624 |
Displaced-Diffusion Extension of the LFM | p. 626 |
Unspanned Stochastic Volatility Jump Models | p. 629 |
Joshi and Rebonato [2003] Model | p. 630 |
Jarrow, Li, and Zhao [2007] Model | p. 631 |
An Extension of the JLZ Model | p. 636 |
Empirical Performance of the JLZ [2007] Model | p. 637 |
Reference | p. 647 |
About the CD-ROM | p. 658 |
Index | p. 661 |
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