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Rev Fin 2000; 13:365-384
© 2000 the Society for Financial Studies

Article

The term structure of interest rates as a random field

RS Goldstein
Fisher College of Business, Ohio State University, 700 Fisher Hall, 2100 Neil Ave., Columbus, OH 43210-1144, USA
E-mail: goldstei@cob.ohio-state.edu

Abstract

Forward rate dynamics are modeled as a random field. In contrast to multifactor models, random field models offer a parsimonious description of term structure dynamics, while eliminating the self-inconsistent practice of recalibration. The form of the drift of the instantaneous forward rate process necessary to preclude arbitrage under the risk-neutral measure is obtained. Forward risk-adjusted measures are identified and used to price a bond option when the forward volatility structure depends on the square root of the current spot rate. Several classes of tractable random field models are presented.


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