A stochastic control perspective on term structure models with roll-over risk
Abstract
In this paper, we consider a generic interest rate market in the presence of roll-over risk, which generates spreads in spot/forward term rates. We do not require classical absence of arbitrage and rely instead on a minimal market viability assumption, which enables us to work in the context of the benchmark approach. In a Markovian setting, we extend the control theoretic approach of Gombani & Runggaldier (2013) and derive representations of spot/forward spreads as value functions of suitable stochastic optimal control problems, formulated under the real-world probability and with power-type objective functionals. We determine endogenously the funding-liquidity spread by relating it to the risk-sensitive optimization problem of a representative investor.
Keywords
Cite
@article{arxiv.2304.04453,
title = {A stochastic control perspective on term structure models with roll-over risk},
author = {Claudio Fontana and Simone Pavarana and Wolfgang J. Runggaldier},
journal= {arXiv preprint arXiv:2304.04453},
year = {2023}
}
Comments
25 pages (revised version)