A VaR-based Model for the Yield Curve

Ruben D Cohen presents an intuitive model for the yield curve, based on the notion of value-at-risk

An intuitive model for the yield curve, based on the notion of value-at-risk, is presented. It leads to interest rates that hedge against potential losses incurred from holding an underlying risky security until maturity. This result is also shown to tie in directly with the Capital Asset Pricing Model via the Sharpe Ratio. The conclusion here is that the normal yield curve can be characterized by a constant Sharpe Ratio, non-dimensionalized with respect to √T, where T is the bond maturity.

Among other features of the model are that it is able to explain, qualitatively if not quantitatively, the existence of (1) a normal yield curve at times of “normal economic growth”, (2) an inverted curve during periods of “high uncertainty”, “high interest rates” or “low economic growth”,1 (3) a flat yield curve in more certain times and (4) a liquidity trap when economic growth is expected to be negative.

Logged-in members can download the article by clicking the link below. To log in or register visit here.

Related Posts

Forecasting the Yield Curve with S-Plus: Wilmott M... Methods capable of forecasting the entire yield curve based on a time series extension of the Nelson-Siegel model Nelson and Siegel (1987) were sugges...
Order Statistics for Value at Risk Estimation and ... We apply order statistics to the setting of VaR estimation. Here techniques like historical and Monte Carlo simulation rely on using the k-th heaviest...
Finformatics: How to Measure Really Small Things Traders in financial assets implicitly compare the trading price to the stream of dividends the assets stand to generate. Clearly, a key determina...
Pricing Rainbow Options A previous paper (West 2005) tackled the issue of calculating accurate uni-, bi- and trivariate normal probabilities. This has important applicati...
Valuation of American Call Options The purpose of this paper is to provide an analytical solution for American call options assuming proportional dividends. Proportional dividends are m...
Life Settlements and Viaticals In this chapter… • life • sex • death 1 Introduction And now for something completely. . .morbid. Life settlements and viaticals are contra...
Calibration problems – An inverse problems v... When pricing structured or derivative financial instruments, the typical steps a quant has to do are the following: 1. Choose a model for the m...
Practical Valuation of Power Derivatives In this paper I look at the practical valuation of power derivatives from a trader’s perspective. Most people that have written about valuation of pow...
Download Here
"A VaR-based Model for the Yield Curve" by Ruben Cohen
120227_cohen