3 - The dynamics of asset prices

Abstract

The modeling of the yield curve is a function of the movement in the price of the underlying asset, which, in this case, is the movement in interest rates. Both option valuation models and interest-rate models describe an environment where the price of an option (or the modeling of the yield curve) is related to the behavior process of the variables that drive asset prices. This process is described as a stochastic process, and pricing models describe the stochastic dynamics of asset price changes, whether it be change in share prices, interest rates, foreign exchange rates, or bond prices. Models that seek to value options or describe a yield curve also describe the dynamics of asset price changes. The same process is said to apply to changes in share prices, bond prices, interest rates, and exchange rates. The price processes of shares and bonds, as well as interest rate processes, are stochastic processes.