Working Paper Series no. 517: Fixed-Income Pricing in a Non-Linear Interest-Rate Model

Abstract

This paper introduces a novel kind of interest-rate model offering simple analytical pricing formulas for swaps, futures, swaptions, caps and floors. The model is based on an original use of regime-switching features that makes it consistent with the non-linear behavior of interest rates. In particular, it accommodates the fact that short-term rate fluctuations are mainly driven by discrete changes in the central-bank policy rates. An application on euro-area data shows how the model can be exploited to infer risk-neutral probabilities of central-bank rate decisions.

Jean-Paul Renne
October 2014

Classification JEL : E43, E47, G12, C53

Keywords : yield curve, option pricing, regime switching, market expectations