Conditional Gaussian models of the term structure of interest rates

Abstract

We present a new family of yield curve models, termed "Conditional Gaussian". It provides both simplicity and extreme flexibility in constructing "market models". Almost any conditional co-variance structure - including features designed to capture volatility "skews" and/or dependence on past returns - can be used, and the model can be embedded into a continuous-time whole yield curve model consistent with general equilibrium. Conditionally Gaussian increments in log one-plus-interest-rates enable "vanilla" and path-dependent derivatives to be valued easily by Monte Carlo, whether or not their payoffs depend solely on the particular market rates being modelled directly.Interest rate models, market models, Conditional Gaussian