Discount Models

TL;DR

This paper introduces an arbitrage-free dynamic framework for discount models, offering an alternative to existing forward rate models, with a focus on affine term structure models and their consistency conditions.

Contribution

It proposes a new arbitrage-free framework for discount models, deriving general conditions and discussing affine models, expanding the theoretical foundation of interest rate modeling.

Findings

Framework ensures arbitrage-free discount modeling

Derives consistency conditions for factor models

Discusses potential research directions

Abstract

Discount is the difference between the face value of a bond and its present value. I propose an arbitrage-free dynamic framework for discount models, which provides an alternative to the Heath--Jarrow--Morton framework for forward rates. I derive general consistency conditions for factor models, and discuss affine term structure models in particular. There are several open problems, and I outline possible directions for further research.