Term structure modelling under entropy maximisation

Session 3: Term Structure Modelling II

Abstract: The possibility of low real interest rates is spurring research on the question of how to increase real yields while limiting the variability of long-term investment payouts. By entropy maximization under the benchmark approach, it is possible to derive realistic market dynamics and benchmark pricing to achieve attractive, almost riskless, non-fluctuating long-term investment results. Payouts of savings account units that provide an almost riskless outcome over a long time period can be hedged reliably as contingent claims by using a stock index and a savings account. This hedge can be performed in a less expensive manner than by traditional methods. Employing the benchmark pricing measure and a stock index as numeraire provides the least expensive hedging strategy for a given contingent claim.