ABSTRACT
A major advantage of the Heath, Jarrow, and Morton term structure model is that it is easily extended to incorporate additional term structures. To price and hedge foreign currency derivatives, one need a spot exchange rate of foreign into domestic currency and two zero-coupon bond price curves: one for the domestic currency and one for the foreign currency. The arbitrage-free conditions correspond to the existence of pseudo probabilities that make all dollar-denominated and dollar-translated securities martingales after normalization by the domestic money market account. Market completeness corresponds to the uniqueness of these pseudo probabilities. Pricing and hedging is done via the risk-neutral valuation procedure. An important extension of the default-free term structure model to multiple term structures is when one includes securities with different levels of bankruptcy risk. Pricing and hedging are done using the risk-neutral valuation procedure.
