This paper reviews the term structure of interest rates literature relating to the arbitrage-free pricing and hedging of interest rate derivatives. Term structure theory is emphasized. Topics included are the HJM model, forward and futures contracts, the expectations hypothesis, and the pricing...

This paper discusses the two different contradicting philosophies for testing models in financial economics (asset pricing, corporate finance, and market-microstructure) using linear regression. We synthesize these two contradicting approaches, document the errors that may occur in the existing...

Unconventional monetary policy tools are based on the belief that there exists a zero-lower bound on interest rates. This paper argues, based on economic theory and the empirical evidence, that this belief is a myth and not a reality. It is shown that a negative default-free spot rate of...

Credit default swaps (CDSs) are term insurance contracts written on traded bonds. This review studies the economics of CDSs using the economics of insurance literature as a basis for analysis. It is alleged that trading in CDSs caused the 2007 credit crisis, and therefore trading CDSs is an evil...

We provide a new liquidity-based model for financial asset price bubbles that explains bubble formation and bubble bursting. The martingale approach to modeling price bubbles assumes that the asset's market price process is exogenous and the fundamental price, the expected future cash flows...

The current derivatives pricing technology enables users to hedge derivatives with the underlying asset or any other traded derivative. In theory, there is no reason to prefer one hedging instrument to another. However, given model errors, this is not true. Imposing some simple assumptions on...

This paper extends and refines the Jarrow et al. (2006, 2008) arbitrage free pricing theory for bubbles to characterize forward and futures prices. Some new insights are obtained in this regard. In particular, we: (i) provide a canonical process for asset price bubbles suitable for empirical...