A New Model for Interest Rates

Publisher Website
Google Scholar
Abstract
There are many theories and models underlying the valuation of fixed income security portfolios. This work addresses the problem from a new perspective: the objective is to find a lower bound for the value of a portfolio of cash flows. We set up conditions for the evolution of a short-term interest rate and value a liability using its present value. We formulate a first-order nonlinear hyperbolic partial differential equation for the value, V, of the portfolio. We explore the solution of this equation and then hedge our portfolio with market-traded zero-coupon bonds of known value. We include some salient examples — generating the Yield Envelope and valuing caps, floors and bond options.