Bond Pricing and the Term Structure of Interest Rates: A Discrete Time Approximation

This paper presents a unifying theory for valuing contingent claims under a stochastic term structure of interest rates. The methodology, based on the equivalent martingale measure technique, takes as given an initial forward rate curve and a family of potential stochastic processes for its subsequent movements. A no-arbitrage condition restricts this family of processes, yielding valuation formula for interest rate sensitive contingent claims that do not explicitly depend on the market prices of risk. Examples are provided to illustrate the key results. Copyright 1992 by The Econometric Society.

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