Abstract
We consider interest rate models of Heath-Jarrow-Morton type where the forward rates are driven by a multidimensional Wiener process, and where the volatility structure is allowed to be a smooth functional of the present forward rate curve. In a recent paper [3], Bjork and Svensson give necessary and sufficient conditions for the existence of a finite dimensional Markovian state space realization (FDR) for such a forward rate model, and in the present paper we provide a general method for the actual construction of an FDR.
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