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Working Papers (1992), ESSEC Business School

Pricing Derivative Securities with a Multi-factor Model of the Yield Curve

BAJEUX-BESNAINOU I., PORTAIT Roland

The martingale approach to pricing contingent claims can be applied in a state variable framework. We use this idea to compute the prices of derivative securities (futures on stock and bond futures, options on stocks, bonds and futures) given a multi-factor model of the returns of stocks and bonds. Our bond model is similar to Langetieg's multi-factor model of the yield curve which has closed-form solutions. This model is a generalization of Vasicek's (77), but the term structure depends in our model on n state variables following correlated mean reverting processes. Our stock market is assumed to be affected by systematic and unsystematic risk.

BAJEUX-BESNAINOU, I. and PORTAIT, R. (1992). Pricing Derivative Securities with a Multi-factor Model of the Yield Curve. ESSEC Business School.