A Term Structure Model for Dividends and Interest Rates

TL;DR

This paper develops a polynomial jump-diffusion model to jointly price dividends and interest rates, providing closed-form prices for various derivatives and demonstrating good empirical fit with market data.

Contribution

It introduces a novel joint term structure model for dividends and interest rates using polynomial jump-diffusions, with closed-form pricing and an efficient approximation method.

Findings

Model fits Euribor interest rate swaps and swaptions

Accurately prices Euro Stoxx 50 dividend futures and options

Provides a unified framework for dividends and interest rates

Abstract

Over the last decade, dividends have become a standalone asset class instead of a mere side product of an equity investment. We introduce a framework based on polynomial jump-diffusions to jointly price the term structures of dividends and interest rates. Prices for dividend futures, bonds, and the dividend paying stock are given in closed form. We present an efficient moment based approximation method for option pricing. In a calibration exercise we show that a parsimonious model specification has a good fit with Euribor interest rate swaps and swaptions, Euro Stoxx 50 index dividend futures and dividend options, and Euro Stoxx 50 index options.