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A Discrete-Time Model for Reinvestment Risk in Bond Markets*

Published online by Cambridge University Press:  17 April 2015

Mikkel Dahl
Mikkel Dahl*
Affiliation:
Markets, Nordea Christiansbro, Strandgade 3, Postbox 850, DK-0900 Copenhagen C, Denmark, Email: [email protected]
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Abstract

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In this paper we propose a discrete-time model with fixed maximum time to maturity of traded bonds. At each trading time, a bond matures and a new bond is introduced in the market, such that the number of traded bonds is constant. The entry price of the newly issued bond depends on the prices of the bonds already traded and a stochastic term independent of the existing bond prices. Hence, we obtain a bond market model for the reinvestment risk, which is present in practice, when hedging long term contracts. In order to determine optimal hedging strategies we consider the criteria of super-replication and risk-minimization.

Keywords

Zero coupon bondincomplete marketforward ratesrisk-minimizationsuper-replication
Type
Articles
Information
ASTIN Bulletin: The Journal of the IAA , Volume 37 , Issue 2 , November 2007 , pp. 235 - 264
Copyright
Copyright © ASTIN Bulletin 2007

Footnotes

*

JEL classification: G10.

Mathematics Subject Classification (2000): 62P05, 91B28.

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