Work

A stochastic control perspective on term structure models with roll-over risk

Year: 2023

Type: article

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 and Runggaldier ( Math. Finance 23 (2013) 659–686) 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 optimisation problem of a representative investor.

Source: Finance and Stochastics

DOI: 10.1007/s00780-023-00515-z

Authors: Claudio Fontana, Simone Pavarana, Wolfgang J. Runggaldier

Institutions: University of Padua, University of Freiburg

Language: English

Topic: Stochastic processes and financial applications

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: hybrid

Estimated APC paid: $2,890

Funder: Università degli Studi di Padova