It is shown how to construct an arbitrage-free short rate model under  uncertainty about the drift and the volatility. The uncertainty is represented by a set of priors, which naturally leads to a G-Brownian motion. Within this framework, it is shown how to characterize the whole term structure without admitting arbitrage. The pricing of zero-coupon bonds in such a setting differs substantially from the traditional models, since the prices need to be chosen in a different way in order to exclude arbitrage.
We construct an arbitrage-free short rate model under Knightian uncertainty about the volatility. The uncertainty is represented by a set of priors, which naturally leads to a G-Brownian motion. Within this framework, it is shown how to characterize the whole term structure without admitting arbitrage. The pricing of zero-coupon bonds in such a setting differs substantially from traditional models, since the prices need to be chosen in a different way in order to exclude arbitrage.
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It is shown how to
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Knightian
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drift and the
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