A market model for pricing inflation indexed bonds with jumps incorporation


Thesis Type: Post Graduate

Institution Of The Thesis: Middle East Technical University, Turkey

Approval Date: 2008

Thesis Language: English

Student: İbrahim Ethem Güney

Consultant: AZİZE HAYFAVİ

Abstract:

Protection against inflation is an essential part of the today's financial markets, particularly in high-inflation economies. Hence, nowadays inflation indexed instruments are being increasingly popular in the world financial markets. In this thesis, we focus on pricing of the inflation-indexed bonds which are the unique inflation-indexed instruments traded in the Turkish bond market. Firstly, we review the Jarrow-Yildirim model which deals with pricing of the inflation-indexed instruments within the HJM framework. Then, we propose a pricing model that is an extension of the Jarrow-Yildirim model. The model allows instantaneous forward rates, inflation index and bond prices to be driven by both a standard Brownian motion and a finite number of Poisson processes. A closed-form pricing formula for an European call option on the inflation index is also derived.