Author(s)

Peter C. L. Lin^1,2

¹Department of Mathematical Sciences, Financial Engineering Division, Stevens Institute of Technology, Hoboken, USA.
²Gamma Paradigm Capital, New York, USA.

The mainstream research in interest-rate modeling has been focusing on a collection of risk tools and pricing formulas which are developed based on the simplified market assumptions and hypotheses. Despite the elegance of the structure, it is noticed that a crucial yet natural factor is missing: the relationship between curve-fitting algorithms and no-arbitrage restrictions on a bond portfolio. Also, the discrepancy between risk-free and default-free bonds is often ignored. This study discusses the modeling conundrums and proposes a framework based on the preferred-habitat hypothesis for advanced term-structure construction that overcomes these limitations in current models. This article serves as an introduction for future work.

Interest-Rate Models, Preferred-Habitat Hypothesis, No-Arbitrage Conditions, Curve-Fitting Algorithms, Bond Portfolios

Lin, P. (2014) Interest-Rate Modeling Conundrums. Journal of Mathematical Finance, 4, 328-332. doi: 10.4236/jmf.2014.45030.