A Simple Regime Switching Term Structure Model
Posted: 29 Jan 2001
We extend the short rate model of Vasicek (1977) to include jumps in the local mean. Conditions ensuring existence of a unique equivalent martingale measure are given, implying that the model is arbitrage-free and complete. We develop efficient numerical methods for computation of zero coupon bond prices, illustrate how the model is easily calibrated to market data and show how other interest rate derivatives can be priced.
Keywords: Regime switching, term structure of interest rates, numerical methods, option pricing
JEL Classification: C15, C63, E43, G13
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