Discount Models

Paper: arXiv 2306.16871

Authors: Damir Filipovic

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.

Complexity vs Empirical Score

• Math Complexity: 8.0/10
• Empirical Rigor: 2.0/10
• Quadrant: Lab Rats — theoretically deep, empirically untested

Why this score: The paper introduces a mathematically sophisticated arbitrage-free dynamic framework for discount models as an alternative to HJM, complete with consistency conditions and affine models. However, it is purely theoretical with virtually no empirical validation or backtesting provided in the abstract.

Research Flowchart

  flowchart TD
    A[Goal: Develop Arbitrage-Free Dynamic Framework for Discount Models] --> B[Input: Bond Face Value & Present Value Dynamics]
    B --> C[Formulate Framework as Alternative to Heath-Jarrow-Morton]
    C --> D[Derive Factor Model Consistency Conditions]
    D --> E[Analyze Affine Term Structure Models]
    E --> F[Outcomes: Validated Discount Models & Open Research Directions]