The APT Model and Variations in the Term Structure of Interest Rates

The main object of this working paper is twofold; firstly, a general model for the variation in the term structure of interest rates, and secondly a universal return model will be defined that combines the expected rate-of-return (ROR) with the pre-defined shift functions. This general model of the variation in the term structure of interest rates will be assumed to belong to the linear class, and, moreover, contains the assumption that the factors that determine the shift function are independent; the model is therefore comparable to the Ross (1976) APT model.The return model for interest-rate-contingent claims that will be defined in this working paper takes into account the time value, incorporates the pattern of the term structure of interest rates, relates the risk measure associated with the defined shift function directly to a return measure, and, finally, contains the feature that the return measure degenerates into the redemption yield if the term structure is flat.The model developed here will be related to Diller's Yield-Surface model and, in the process, it will be demonstrated that the return model thus constructed is compatible with a multi-factor Heath, Jarrow and Morton model, with a preference structure of a specific kind