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The expectations hypothesis of the term structure of interest rates (whose graphical representation is known as the yield curve) is the proposition that the long-term rate is determined purely by current and future expected short-term rates, in such a way that the expected final value of wealth from investing in a sequence of short-term bonds equals the final value of wealth from investing in ...
The opposite situation can also occur, in which the yield curve is "inverted", with short-term interest rates higher than long-term. For instance, in November 2004, the yield curve for UK Government bonds was partially inverted. The yield for the 10-year bond stood at 4.68%, but was only 4.45% for the 30-year bond.
The HJM framework originates from the work of David Heath, Robert A. Jarrow, and Andrew Morton in the late 1980s, especially Bond pricing and the term structure of interest rates: a new methodology (1987) – working paper, Cornell University, and Bond pricing and the term structure of interest rates: a new methodology (1989) – working paper ...
An affine term structure model is a financial model that relates zero-coupon bond prices (i.e. the discount curve) to a spot rate model. It is particularly useful for deriving the yield curve – the process of determining spot rate model inputs from observable bond market data.
θ is calculated from the initial yield curve describing the current term structure of interest rates. Typically α is left as a user input (for example it may be estimated from historical data). σ is determined via calibration to a set of caplets and swaptions readily tradeable in the market.
The "expectations theory" holds that long-term rates depicted in the yield curve are a reflection of expected future short-term rates, [9] which in turn reflect expectations about future economic conditions and monetary policy. In this view, an inverted yield curve implies that investors expect lower interest rates at some point in the future ...
In financial mathematics, the Black–Karasinski model is a mathematical model of the term structure of interest rates; see short-rate model.It is a one-factor model as it describes interest rate movements as driven by a single source of randomness.
Interest Rate Modelling. Wiley Finance. ISBN 978-0-471-97523-6. Rajna Gibson, François-Serge Lhabitant and Denis Talay (2001). Modeling the Term Structure of Interest Rates: A Review of the Literature. RiskLab, ETH. Frank J. Fabozzi and Moorad Choudhry (2007). The Handbook of European Fixed Income Securities. Wiley Finance. ISBN 978-0-471-43039-1.