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 Modeling Fixed Income
Securities and Interest Rate
Options
Third Edition
 CHAPMAN & HALL/CRC
Financial Mathematics Series
Series Editors
M.A.H. Dempster
Centre for Financial Research
Department of Pure Mathematics and Statistics
University of Cambridge
Dilip B. Madan
Robert H. Smith School of Business
University of Maryland
Rama Cont
Department of Mathematics
Imperial College

Aims and scope:

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trum of this field. It will include a broad range of textbooks, reference works and handbooks
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code and concrete real-world examples is highly encouraged.

Equity-Linked Life Insurance

Partial Hedging Methods
Alexander Melnikov, Amir Nosrati

High-Performance Computing in Finance

Problems, Methods, and Solutions
M. A. H. Dempster, Juho Kanniainen, John Keane, Erik Vynckier

An Introduction to Computational Risk Management of Equity-Linked Insurance

Runhuan Feng

Derivative Pricing
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Ambrose Lo

Portfolio Rebalancing
Edward E. Qian

Interest Rate Modeling

Theory and Practice, 2nd Edition
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Modeling Fixed Income Securities and Interest Rate Options

Robert A. Jarrow

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 Modeling Fixed Income
Securities and Interest Rate
Options
Third Edition

Robert A. Jarrow
CRC Press
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This book is dedicated to my wife Gail.
Contents

Preface to the Third Edition, xv

Section I  Introduction

Chapter 1   ◾   Introduction 3
1.1 THE APPROACH 3
1.2 MOTIVATION 4
1.3 THE METHODOLOGY 8
1.4 AN OVERVIEW 10
REFERENCES 12

Chapter 2   ◾   Traded Securities 13

2.1 TREASURY SECURITIES 13
2.2 TREASURY SECURITY MARKETS 15
2.3 REPO MARKETS 17
2.4 TREASURY FUTURES MARKETS 18
2.5 INTEREST RATE DERIVATIVES ON TREASURIES 19
2.6 EURODOLLAR SPOT, FORWARD, AND FUTURES
MARKETS 20
2.7 INTEREST RATE DERIVATIVES ON LIBOR 21
REFERENCES 21

Chapter 3   ◾   The Classical Approach 23

3.1 MOTIVATION 23
3.2 COUPON BONDS 23

vii
viii   ◾    Contents

3.3 THE BOND’S YIELD, DURATION, MODIFIED

DURATION, AND CONVEXITY 26
3.4 RISK MANAGEMENT 33
REFERENCE 38

Section II  Theory

Chapter 4   ◾   The Term Structure of Interest Rates 41

4.1 THE ECONOMY 42
4.2 THE TRADED SECURITIES 42
4.3 INTEREST RATES 44
4.4 FORWARD PRICES 48
4.5 FUTURES PRICES 50
4.6 OPTION CONTRACTS 52
4.6.1 Definitions 53
4.6.2 Payoff Diagrams 53
4.7 SUMMARY 56
REFERENCES 56

Chapter 5   ◾   The Evolution of the Term Structure of

Interest Rates 57
5.1 MOTIVATION 57
5.2 THE ONE-FACTOR ECONOMY 61
5.2.1 The State Space Process 62
5.2.2 The Bond Price Process 65
5.2.3 The Forward Rate Process 72
5.2.4 The Spot Rate Process 78
5.3 THE TWO-FACTOR ECONOMY 80
5.3.1 The State Space Process 80
5.3.2 The Bond Price Process 81
5.3.3 The Forward Rate Process 82
5.3.4 The Spot Rate Process 83
5.4 N ≥ 3-FACTOR ECONOMIES 83
 Contents   ◾   ix

5.5 CONSISTENCY WITH EQUILIBRIUM 83

REFERENCES 84

Chapter 6   ◾   The Expectations Hypothesis 85

6.1 MOTIVATION 85
6.2 PRESENT VALUE FORM 86
6.3 UNBIASED FORWARD RATE FORM 90
6.4 RELATION BETWEEN THE TWO VERSIONS OF THE
EXPECTATIONS HYPOTHESIS 94
6.5 EMPIRICAL ILLUSTRATION 95
6.5.1 Present Value Form 96
6.5.2 Unbiased Forward Rate Form 97
REFERENCES 98

Chapter 7   ◾   Trading Strategies, Arbitrage Opportunities,

and Complete Markets 99
7.1 MOTIVATION 99
7.2 TRADING STRATEGIES 100
7.3 ARBITRAGE OPPORTUNITIES 110
7.4 COMPLETE MARKETS 114

Chapter 8   ◾   Bond Trading Strategies – An Example 121

8.1 MOTIVATION 121
8.2 METHOD 1: SYNTHETIC CONSTRUCTION 122
8.2.1 An Arbitrage-Free Evolution 123
8.2.2 Complete Markets 124
8.3 METHOD 2: RISK-NEUTRAL VALUATION 130
8.3.1 Risk-Neutral Probabilities 130
8.3.2 Risk-Neutral Valuation 133
8.3.3 Exploiting an Arbitrage Opportunity 134

Chapter 9   ◾   Bond Trading Strategies – The Theory 137

9.1 THE ONE-FACTOR ECONOMY 137
9.1.1 Complete Markets 138
x   ◾    Contents

9.1.2 Risk-Neutral Probabilities 142

9.1.3 Risk-Neutral Valuation 146
9.1.4 Bond Trading Strategies 150
9.2 THE TWO-FACTOR ECONOMY 151
9.2.1 Complete Markets 151
9.2.2 Risk-Neutral Probabilities 156
9.2.3 Risk-Neutral Valuation 161
9.2.4 Bond Trading Strategies 163
9.3 MULTIPLE FACTOR ECONOMIES 163
APPENDIX 163
REFERENCES 165

Chapter 10   ◾   Contingent Claims Valuation – Theory 167

10.1 MOTIVATION 167
10.2 THE ONE-FACTOR ECONOMY 168
10.2.1 Complete Markets 176
10.2.2 Risk-Neutral Probabilities 176
10.2.3 Risk-Neutral Valuation 181
10.3 THE TWO-FACTOR ECONOMY 181
10.3.1 Complete Markets 182
10.3.2 Risk-Neutral Probabilities 182
10.3.3 Risk-Neutral Valuation 183
10.4 MULTIPLE FACTOR ECONOMIES 184
APPENDIX 184

Section III  Applications

Chapter 11   ◾   Coupon Bonds 189

11.1 THE COUPON BOND AS A PORTFOLIO OF
ZERO-COUPON BONDS 190
11.2 THE COUPON BOND AS A DYNAMIC TRADING
STRATEGY 193
11.3 COMPARISON OF HJM HEDGING VERSUS
DURATION HEDGING 200
 Contents   ◾   xi

Chapter 12   ◾   Options on Bonds 205

12.1 DISTRIBUTION-FREE OPTION THEORY 206
12.1.1 Call Options 206
12.1.2 Put Options 209
12.1.3 Put-Call Parity 210
12.2 EUROPEAN OPTIONS ON ZERO-COUPON BONDS 211
12.3 AMERICAN OPTIONS ON COUPON BONDS 217
12.4 CALL PROVISIONS ON COUPON BONDS 225
REFERENCES 229

Chapter 13   ◾   Forwards and Futures 231

13.1 FORWARDS 232
13.2 FUTURES 238
13.3 THE RELATIONSHIP BETWEEN FORWARD AND
FUTURES PRICES 244
13.4 OPTIONS ON FUTURES 248
13.5 EXCHANGE-TRADED TREASURY FUTURES
CONTRACTS 251
REFERENCES 252

Chapter 14   ◾   Swaps, Caps, Floors, and Swaptions 253

14.1 FIXED-RATE AND FLOATING-RATE LOANS 254
14.2 INTEREST RATE SWAPS 258
14.2.1 Swap Valuation 258
14.2.2 The Swap Rate 260
14.2.3 Synthetic Swaps 264
14.2.3.1 Swap Construction Using FRAs 265
14.2.3.2 Synthetic Swap Construction using a
Dynamic Trading Strategy 266
14.3 INTEREST RATE CAPS 268
14.4 INTEREST RATE FLOORS 272
14.5 SWAPTIONS 277
REFERENCES 280
xii   ◾    Contents

Chapter 15   ◾   Interest Rate Exotics 281

15.1 SIMPLE INTEREST RATES 281
15.2 DIGITAL OPTIONS 283
15.3 RANGE NOTES 286
15.4 INDEX-AMORTIZING SWAPS 292
REFERENCES 299

Section IV Implementation/Estimation

Chapter 16   ◾   Continuous-Time Limits 303

16.1 MOTIVATION 303
16.2 ONE-FACTOR ECONOMY 307
16.2.1 Arbitrage-Free Restrictions 310
16.2.2 Computation of the Arbitrage-Free Term Structure
Evolutions 315
16.2.3 The Continuous-Time Limit 319
16.3 TWO-FACTOR ECONOMY 323
16.3.1 Arbitrage-Free Restrictions 325
16.3.2 Computation of the Arbitrage-Free Term Structure
Evolutions 326
16.4 MULTIPLE-FACTOR ECONOMIES 328
16.5 COMPUTATIONAL ISSUES 329
16.5.1 Bushy Trees 329
16.5.2 Lattices 330
16.5.3 Monte Carlo Simulation 331
REFERENCES 331

Chapter 17   ◾   Parameter Estimation 333

17.1 COUPON BOND STRIPPING 333
17.2 THE INITIAL FORWARD RATE CURVE 336
17.3 VOLATILITY FUNCTION ESTIMATION 338
17.3.1 Historic Volatilities 339
17.3.2 Implicit Volatilities 341
 Contents   ◾   xiii

17.4 APPLICATION TO COUPON BOND DATA 342

17.4.1 Coupon Bond Stripping and Forward Rate
Estimation 343
17.4.2 Volatility Function Estimation – Principal
Components Analysis 345
17.4.3 Volatility Function Estimation – A One-Factor
Model with Exponentially Declining Volatility 349
APPENDIX 354
REFERENCES 357

Chapter 18   ◾   Extensions 359

18.1 FOREIGN CURRENCY DERIVATIVES 359
18.2 CREDIT DERIVATIVES AND COUNTERPARTY RISK 360
18.3 COMMODITY DERIVATIVES 361
REFERENCES 361

INDEX, 363
Preface to the
Third Edition

T his book is entitled Modeling Fixed-Income Securities and Interest

Rate Options. Its primary purpose is to teach students the basics of
fixed-income securities, but not in the fashion of traditional courses and
texts in this area. Traditional fixed-income courses and texts empha-
size institutional details, with theories included in an ad hoc fashion
and only occasionally. In contrast, this book teaches the basics of fixed-
income securities from a unified theoretical framework. The framework
is that of the arbitrage-free pricing and complete markets methodol-
ogy. This textbook is therefore more abstract than traditional textbooks
in this area. This is the reason for the word modeling in the title. It is
the hope (and belief) of this author, however, that this material is the
approach of the future.
As a secondary purpose, this textbook explains the arbitrage-free term
structure models used for pricing interest rate derivatives with particular
emphasis on the Heath-Jarrow-Morton model and its applications. It is
designed to make the Heath-Jarrow-Morton model accessible to MBAs
and advanced undergraduates, with a minimum of course prerequisites.
The course prerequisites are just some familiarity with high school alge-
bra and mathematical reasoning. This textbook has already been used
multiple times for an MBA class at Cornell’s Johnson Graduate School of
Management on fixed-income securities with no prerequisites other than
a basic core finance course and a core quantitative methods course.
Contrary to what a quick skimming of this text might suggest, this book
is designed for an MBA elective. Each chapter’s material is introduced
through examples. The examples themselves are designed to illustrate
the key concepts. The formal and more general presentation of the same

xv
xvi   ◾   Preface to the Third Edition

material follows after the examples. This organization facilitates various

levels of presentation. For an MBA elective, only the examples should be
discussed in class. The formal presentation is left for background reading.
For the Ph.D. level, the reverse ordering is appropriate.
This edition differs from the second only in that it is updated to remove
typos, to polish the prose, and to reflect new insights from the literature
and changes in current market structures.
This manuscript’s organization and content were greatly influenced by
the comments from reviewers, friends, and students. Thanks are espe-
cially extended to Arkadev Chatterjea, Joseph Cherian, Steve Choi, Raoul
Davie, William Dimm, Blair Kanbar, Heedong Kim, David Heath, David
Lando, Bill Margrabe, Sam Priyadarshi, Tal Schwartz, Ahmet Senoglu,
Stuart Turnbull, Don van Deventer, and Yildiray Yildirim.
 I
Introduction

1
 Chapter 1

Introduction

1.1 THE APPROACH
This book studies an approach for understanding and analyzing fixed income
securities and interest rate options that has revolutionized Wall Street. The
approach is to apply the tools of derivatives pricing and hedging to under-
stand the risk management of fixed income securities. This is in contrast to
the traditional focus of textbooks in this area. Traditional textbooks concen-
trate on the institutional setting of fixed income markets, which consists of
descriptions of the various markets and the instruments that trade within –
e.g., the key players, conventions in quoting prices, and contract specifics.
Risk management – the pricing and hedging of fixed income securities –
is, at best, only an afterthought. Traditional fixed income textbooks often
introduce pricing theories in an ad hoc and inconsistent fashion. Today,
with the advent of sophisticated and readily available computer technology
that can be applied to study these securities, the traditional approach is now
outdated. Although institutional details are still important, their impor-
tance is now secondary to risk management considerations.
This book provides a self-contained study of this new approach for pric-
ing and hedging fixed income securities and interest rate options. This
new approach is based on the Heath, Jarrow, and Morton (HJM) model,
an interest rate derivatives pricing model, which is used extensively in the
industry. The HJM model was developed by Heath, Jarrow, and Morton in
a sequence of papers.* It was motivated by the earlier work of Ho and Lee†

* See Heath, Jarrow, Morton [2,3,4]. Also see Jarrow [6] for a review of the history behind the devel-
opment of the HJM model.
† See Ho and Lee [5].

3
4   ◾    Modeling Fixed Income Securities and Interest Rate Options

on this same topic, and by the martingale pricing methods of Harrison

and Pliska.*
The HJM model is presented using the standard binomial model so
often used to analyze the pricing and hedging of equity options. The
standard binomial model is chosen because of its mathematical simplic-
ity, in comparison to the more complex stochastic calculus techniques.
In addition, this is with little loss of generality, as the alternative and
more complex stochastic calculus techniques still need to be numerically
implemented on a computer, and a standard approach for implementing
these techniques on the computer is to use the binomial model. So, from
an implementation point of view, the binomial model is all one needs to
master.
This flexible, new approach to fixed income securities has revolution-
ized the industry. The HJM model is employed by commercial and invest-
ment banks to price and hedge numerous types of fixed income securities
and interest rate options. One reason for its extensive use is that this model
provides a “lego” building block technology. With minor modifications,
this technology can be easily extended (built upon) to handle the pric-
ing of other more complex instruments, e.g., foreign currency derivatives,
commodity derivatives, and credit derivatives. These extensions will also
be illustrated, albeit briefly, in this book.

1.2 MOTIVATION
Examining three figures can motivate the subject matter of this textbook.
The first, Figure 1.1, contains the graph of a yield curve for Treasury secu-
rities. For now, do not worry about the exact definition of a Treasury secu-
rity or its yield. These will be discussed more fully, later on in the text.
Here, it suffices to understand that Treasury securities are bonds issued
by the U.S. government. A bond is an IOU issued for borrowing a stated
amount of dollars (e.g., $10,000), called the principal, for a fixed period of
time (e.g., 5 years), called the bond’s maturity. Interest is paid regularly
(often semi-annually) on this IOU. A Treasury bond’s yield can be thought
of as the interest earned per year from buying and holding the bond until
its maturity.
In Figure 1.1 we see a Treasury yield curve on December 12, 2018. The
y-axis units are percentages per year. The y-axis starts at 0 percent. The
x-axis gives the different bonds’ maturities in years. The maturities run

* See Harrison and Pliska [1].

 Introduction   ◾   5

FIGURE 1.1 Treasury Bond Yields on December 12, 2018.

from 1 month to 30 years. As depicted, the yield curve is upward sloping,

indicating that it costs more to borrow for 30 years than it does for 5 years
or for 1 year. The longer the borrowing horizon, the larger the interest rate
charged per year. This increasing interest rate reflects the different risks of
the longer borrowing horizons and the market’s perception of how short-
term interest rates will change in the future.
The Treasury yield curve changes through time. This change is illus-
trated in Figure 1.2, which repeats Figure 1.1, but graphs it at different
dates over the time period from January 2014 through January 2019. As
seen, the yield curve’s shape and height differ at different times over this
5-year period. Sometimes the yield curve is nearly flat (see January 2019).
The shape of the yield curve is referred to as the term structure of interest
rates. Its fluctuation through time is called the evolution of the term struc-
ture of interest rates. This evolution is random because it is not predict-
able in advance. Forecasting the evolution of the term structure of interest
rates well is crucial for risk management procedures. Models for the evo-
lution of the term structure of interest rates will form a big part of this
book’s content.
Interest rate options or derivatives are financial contracts whose cash
flows depend, contractually, on the Treasury yield curve as it evolves
6   ◾    Modeling Fixed Income Securities and Interest Rate Options

FIGURE 1.2 Yields from January 2014 to December 2018.

through time. For example, one such interest rate derivative is a financial
contract that pays its owner on the second anniversary date of the con-
tract (its maturity date), $10,000 times the difference between the 10-year
and 5-year yields observed on the maturity date, but only if this difference
is positive. This is a call option on an interest rate spread. To understand
how to price this spread option, one needs to understand (or model) how
the term structure of interest rates evolves through time. The better the
model (or forecast) of the term structure evolution, the better the pricing
model will be. After all, the expectation of the profits or losses from the
spread option depends on what the shape of the term structure looks like
in 2 years.
A key theme in this book, therefore, is how to model the evolution of
the term structure of interest rates illustrated in Figure 1.2. Much of our
emphasis will be on developing this structure. Then, given this evolution,
the second theme is how to price and hedge the interest rate derivatives
written on it. This is a nontrivial exercise and reflects the remaining focus
of the book. This topic is referred to as risk management.
A key characteristic of U.S. Treasury securities is that they are con-
sidered to be default-free. That is, an IOU issued by the U.S. government
is considered to be safe, with the receipt of the interest and principal
payments considered a sure bet. Of course, not all IOUs are so safe.
Corporations and government municipalities also borrow by issuing
bonds. These corporate and municipal loans can default and have done
so in the past. The interest and principal owed on these loans may not
be paid in full if the corporation or municipality defaults prior to the
 Introduction   ◾   7

FIGURE 1.3 Various Bond Yields.

maturity date of the borrowing. This different default risk generates dif-
ferent interest rates for different borrowers, reflecting a credit risk spread,
as illustrated in Figure 1.3.
Figure 1.3 plots the average yields per year on Treasury, corporate, and
municipal bonds over the years 2009 through 2018. The y-axis units are
percentages per year, and it starts at 1.5 percent. The x-axis units are time
measured in years from 2009 to 2018. As seen, the cost for borrowing is
higher for corporates than it is for Treasuries. Surprisingly, however, the
cost for borrowing is higher for Treasuries than it is for municipals. The
corporate-–Treasury spread (positive) is due to credit risk. This credit
spread represents the additional compensation required in the market for
bearing the risk of default. The Treasury-–municipal spread (negative) is
due to both default risk and the differential tax treatments on Treasuries
versus municipals. Treasuries and corporates are taxed similarly at the
federal level. So, tax differences do not influence their spread. In contrast,
U.S. Treasury bond income is taxed at the federal level, while municipal
bond income is not. This differential tax treatment influences the spread.
As seen, the tax benefit of holding municipals dominates the credit risk
involved, making the municipal borrowing rate less than the Treasury
8   ◾    Modeling Fixed Income Securities and Interest Rate Options

rate. Understanding the different spreads between various fixed income

securities is an important aspect of fixed income markets.
Unfortunately, for brevity, this book concentrates almost exclusively on
the Treasury curve (default-free borrowing), and it ignores both credit risk
and taxation. Nonetheless, this is not too big an omission. It turns out
that if one understands how to price interest rate derivatives issued against
Treasuries, then extending this technology to derivatives issued against
corporates or municipals is (conceptually) straightforward. This is due to
the “lego” building block aspect of the HJM technology. Consequently,
most of the economics of fixed income markets can be understood by con-
sidering only Treasury markets.
This claim can be intuitively understood by studying the similarity
in the evolutions of the three different yields – Treasuries, corporates,
municipals – as depicted in Figure 1.3. The movements in these three
rates are highly correlated, almost moving in a parallel fashion. As one
rate increases, so do the remaining two. As one declines, so do the others,
although the magnitudes of the changes may differ. A good model for one
rate, with some obvious adjustments, therefore, will also be a good model
for the others. This implies that the same pricing technology should also
apply. And, it does. Therefore, the same risk management practices can
be utilized for all three types of fixed income securities. Consequently,
mastering risk management for Treasury securities is almost sufficient for
mastering the risk management techniques for the rest. The last chapter in
the book will briefly solidify this intuition.

1.3 THE METHODOLOGY
As mentioned earlier, we use the standard binomial option pricing meth-
odology to study the pricing and hedging of fixed income securities and
interest rate options. The binomial approach is easy to understand, and it
is widely used in practice. It underlies the famous Black-Scholes-Merton
option pricing model.* As shown later, the only difference between the
application of these techniques to fixed income securities and those used
for pricing equity options is in the construction of a more complex bino-
mial tree. To understand this difference, let us briefly review the standard
binomial pricing model.
A diagram with nodes and two branches emanating from each node
on the tree is called a binomial tree (see Figure 1.4). The nodes occur at

* An excellent reference for the Black-Scholes-Merton option pricing model is Jarrow and Chatterjea [7].
 Introduction   ◾   9


branches

 

nodes

time 0
time 1 
time 2

FIGURE 1.4 A Binomial Tree.

particular times, e.g., times 0, 1, 2, and so forth. The nodes represent the
state of the economy at these various times. The first node at time 0 repre-
sents the present (today’s) state of the economy. The future states possible
at times 1 and 2 are random. The branches represent the paths for reaching
these nodes, called histories.
For risk management purposes, the relevant state of the economy at
each node is characterized by the prices of some set of securities. For equity
options, a single security’s price is usually provided at each node, the price
of the underlying equity. For fixed income securities, an array (a vector) of
bond prices is considered at each node of the tree, rather than the single
equity’s price (a scalar) as in the case of equity options. Otherwise, the two
trees are identical. Hence, term structure modeling is just the multidi-
mensional extension of the standard equity pricing model. Unfortunately,
this multidimensional extension to a vector of prices at each node of the
tree is nontrivial. The complexity comes in ensuring that the given evolu-
tion of prices is arbitrage-free.
By arbitrage-free we mean that the prices in the tree are such that there
are no trading strategies possible using the different bonds that can gen-
erate profits with no initial investment and with no risk of a loss. For
an equity pricing model, constructing an arbitrage-free binomial tree is
trivial. For fixed income pricing models, however, constructing an arbi-
trage-free binomial tree is quite complex. Quantifying the conditions
under which this construction is possible is, in fact, the key contribution
of the HJM model to the literature. Once this arbitrage-free construction
is accomplished, the standard binomial pricing arguments apply.
10   ◾    Modeling Fixed Income Securities and Interest Rate Options

The standard binomial pricing argument determines the arbitrage-free

price of a traded derivative security, in a frictionless and competitive mar-
ket, where there is no counterparty risk (these terms are explained later
in the text). It does this by constructing a synthetic derivative security,
represented by a portfolio of some underlying assets (bonds) and a risk-
less money market account. This portfolio is often modified, rebalanced,
through time in a dynamic fashion. This portfolio’s (the synthetic deriva-
tive security’s) cash flows are constructed to exactly match those of the
traded derivative security, but the synthetic derivative security’s cost of
construction is known. This cost of construction represents the “fair” or
“theoretical” value of the derivative security.
Indeed, if the traded derivative security’s price differs from the theo-
retical value, an arbitrage opportunity is implied. For example, suppose
the theoretical price is lower than the traded price. Then, sell the traded
derivative (a cash inflow) and construct it synthetically (a cash outflow).
The difference in cash flows is positive because the traded price is above
the cost of construction. One pockets this initial dollar difference, and
there is no future liability, as the cash flows are equal and opposite from
thereon.
The identification of such arbitrage opportunities is one of the most
popular uses of these techniques in practice. Other uses are in the area of
risk management, and these uses will become more apparent as the pric-
ing and hedging techniques are mastered.

1.4 AN OVERVIEW
This book is divided into four parts. Part I is an introduction to the mate-
rial studied in this book. Part II describes the economic theory underlying
the HJM model. Part III applies the theory to specific applications, while
Part IV studies implementation and estimation issues, as well as exten-
sions of the HJM model to foreign currency derivatives, credit derivatives,
and commodity derivatives.
Part I, the introduction, consists of three chapters. Chapter 1 is the
introduction, the current chapter. Chapter 2 gives the institutional
description of the fixed income security and interest rate derivative
markets. Included are Treasury securities, repo markets, Forward Rate
Agreements (FRAs), Treasury futures, caps, floors, swaps, swaptions, and
other exotics. This presentation is brief with additional references pro-
vided. Chapter 3 describes the classical approach to fixed income security
risk management. The classical approach concentrates on yields, duration,
 Introduction   ◾   11

and convexity. The classical approach is studied for two reasons. First, it
is still in use today, although its use is diminishing as time progresses.
Second, and perhaps most important, understanding the limitations of
these classical techniques provides the motivation for the HJM model pre-
sented in Part II.
Part II presents the HJM model’s theoretical framework. Chapter 4
introduces the notation, terminology, and assumptions used in the
remainder of the text. The traded securities are discussed, where, for the
sake of understanding, many of the actually traded financial securities are
simplified. Chapter 5 sets up the binomial tree for the entire term struc-
ture of zero-coupon bonds. A one-factor model is emphasized in Chapter 5
and throughout the remainder of the text. Markets with two or more fac-
tors are also considered. Chapter 6 describes the traditional expectations
hypothesis, which, after a curious transformation, becomes essential to
the pricing methodology used in subsequent chapters. Chapter 7 intro-
duces the basic tools of analysis: trading strategies, arbitrage opportuni-
ties, and complete markets. Chapter 8 illustrates the use of these tools for
zero-coupon bond trading strategies with an example. Chapter 9 provides
the formal theory underlying Chapter 8. Finally, Chapter 10 discusses
option-pricing theory in the context of the term structure of interest rates.
Part III consists of various applications of this pricing and hedging tech-
nology. Chapter 11 studies the pricing of coupon bonds. Chapter 12 inves-
tigates the pricing of options on bonds (both European and American).
Chapter 13 studies the pricing and hedging of forwards, futures, and
options on futures. Chapter 14 analyzes swaps, caps, floors, and swaptions.
Chapter 15 prices various interest rate exotic options including digitals,
range notes, and index-amortizing swaps. Index-amortizing swaps are
considered to be one of the most complex interest rate derivatives traded.
They will be seen as just a special, albeit more complex, example of our
pricing technology.
Part IV investigates implementation and estimation issues. Chapter 16
shows that the model of Parts I–III can serve as a discrete time approxima-
tion to the continuous time HJM model. Both the continuous time HJM
model and its limits are studied herein. Chapter 17 investigates the sta-
tistical estimation of the inputs: forward rate curves and volatility func-
tions. Empirical estimation of these inputs is also provided in this chapter.
Chapter 18 completes the book with a discussion of various extensions
and a list of suggested references. The extensions are to foreign currency
derivatives, credit derivatives, and commodity derivatives.
12   ◾    Modeling Fixed Income Securities and Interest Rate Options

REFERENCES
1. Harrison, J. M., and S. Pliska, 1981. “Martingales and Stochastic Integrals
in the Theory of Continuous Trading.” Stochastic Processes and Their
Applications 11, 215–260.
2. Heath, D., R. Jarrow, and A. Morton, 1990. “Bond Pricing and the Term
Structure of Interest Rates: A Discrete Time Approximation.” Journal of
Financial and Quantitative Analysis 25 (4), 419–440.
3. Heath, D., R. Jarrow, and A. Morton, 1990. “Contingent Claim Valuation
with a Random Evolution of Interest Rates.” Review of Futures Markets 9 (1),
54–76.
4. Heath, D., R. Jarrow, and A. Morton, 1992. “Bond Pricing and the Term
Structure of Interest Rates: A New Methodology for Contingent Claims
Valuation.” Econometrica 60 (1), 77–105.
5. Ho, T. S., and S. Lee, 1986. “Term Structure Movements and Pricing Interest
Rate Contingent Claims.” Journal of Finance 41, 1011–1028.
6. Jarrow, R., 1997. “The HJM Model: Past, Present, Future.” Journal of
Financial Engineering 6 (4), 269–280.
7. Jarrow, R., and A. Chatterjea, 2019. An Introduction to Derivative Securities,
Financial Markets, and Risk Management, 2nd edition, World Scientific
Press.
Another Random Scribd Document
with Unrelated Content
 To prevent a recurrence of circumstances so little honourable to
the french name, a decree was at last past, for clearing away all the
monuments erected in the Pantheon, excepting those of Voltaire and
Rousseau. These I determined to visit. We accordingly descended
into the vaults, which are neat, clean, well lighted, stone apartments,
where we found the tombs of these celebrated men. On that of
Rousseau only the following words are written:

“Ici répose l’homme de la nature et de la vérité[56];” and a

hand with a torch rises from the tomb, with this inscription, “il
éclairit le monde même du tombeau[57].”
On the monument of Voltaire, the following epitaph is
written on one side.
“Aux manes de Voltaire,
L’Assemblée nationale
A décrétée le 30 mai, 1791,
Qu’il avoit mérité les honneurs
Dûs aux grandes hommes[58].”
On the second side.
“Poet, historien, philosophe,
Il aggrandit l’esprit humain,
Et l’apprit, qu’il devoit être libre[59].”
On the third side.
“Il défendit Calas,
Serven,
De la Barre et Mont Bally[60].”
On the fourth side.
“Il combattit les athées
Et les fanatiques.
Il inspira la tolérance.
Il réclama les droits de l’homme,
Contre le monstre de la féodalité[61].”
 The bones of these distinguished men are in the tombs, which I
have described. Rousseau was removed from the garden of
Ermenonville, where his shade reposed in its favourite retreat, under
the auspices of friendship; and the heart of Voltaire, which had
remained for some years, as he desired, among those whom he
loved at Ferney, was dragged from its former resting place to this
more splendid, but less tranquil sepulchre.
I am, &c.
 LETTER XXIII.
Concordat with the Pope ratified by the legislative body after an eloquent
speech by Lucien Bonaparte.—Madame Bonaparte’s first drawing
room.—Appearance of Dehayes at the opera, after a long absence.

Paris, april the 10th, 1802, (20 germinal.)

my dear sir,
On thursday last, the legislative body, after a speech from Lucien
Bonaparte, brother of the consul; who, as orator of the tribunate,
very eloquently defended this favourite measure of government;
ratified and approved the concordat with the Pope, by a large
majority. The reestablishment of religion is therefore determined. I
was not present on the occasion; but persons capable of judging,
assure me, that Lucien’s delivery was remarkably good; and that his
speech was the finest heard in France, since the time of Mirabeau.
As it will, of course, appear in the Moniteur, I shall not attempt to
copy any of those imperfect statements which are, already, handed
about.
Madame Bonaparte held, the same day, for the first time, a kind of
court: that is to say, a card, being previously sent round by the
prefect of the palace, who answers to our master of the ceremonies,
saying, that madame Bonaparte would, at three o’clock, receive the
wives of foreign ministers; and “des étrangers de marque,” such
ladies as wished to be presented, accompanied their respective
ambassadors, at the appointed time, to the palace of the Thuilleries.
As Mrs. ⸺ was of the number, you may depend on the account,
which I shall now send you. The ladies were not in hoops or lappets;
but were, in other respects, as much dressed as they would have
been at St. James’s. They were received by the wife of the préfect
du palais, in the apartments appropriate to madame Bonaparte. She
and the first consul, soon after appeared. A circle was then formed,
and the consul walked round. In passing, he spoke to each lady with
much politeness. Madame Bonaparte went through the same
ceremony; and at last, seated herself, desiring her guests to follow
her example. She talked again to those, who happened to be near
her; and, after an interval of a few minutes, she rose, courtesied,
thanked the ladies for the honour they had done her, and then
retired. I understood that she behaved with great propriety. Her
manners were simple, easy, and unaffected. She was polite to every
one; and particularly civil to the english. Her apartments, on the
ground floor, looking on the Thuilleries, are not large; but they are
furnished with elegance, and considerable taste. Her footmen were
splendidly dressed in green liveries, laced with gold; and they, as
well as the “valets de chambre,” who waited in the antichamber,
were particularly civil, respectful, and attentive. There were no
foreign men present, excepting the ambassadors, and the prince of
Orange; but it is understood, that she will soon have a drawing-room,
for the purpose of receiving such strangers, as are desirous of being
introduced.
I shall conclude this letter, with a short account of the opera, from
which I am just returned. The house was uncommonly crowded, on
account of the first appearance this season, of the dancer Dehayes.
This favourite performer, having been absent more than a year, in
consequence of a fall, which rendered him incapable, during that
time, of pursuing his profession, was received with every possible
honour. A ballet, called “le Retour de Zéphyr[62],” was composed on
the occasion; and the light and gentle Zephyr was welcomed with
loud and repeated applauses. His strength is not quite restored; but
it is easy to see, that he is no mean proficient in the art of dancing.
His steps are perfect, and perhaps not inferior to those of Vestris; but
in point of grace, the comparison is infinitely in favour of the latter.
It is said, that Dehayes was convicted, during the time of
Robespierre, of an attempt to emigrate to England. He was
condemned to the guillotine; but afterwards pardoned, on condition
of dancing, during the whole of one season, without fee or reward,
before “le peuple souverain.” The agility, therefore, of a dancer,
obtained that mercy, which was refused to the innocence of youth, to
the gray hairs of age, to the purity of virtue, to the charms of beauty,
and to the dignity of talent. After this example of the power it
possesses, the art of dancing ought certainly to be ranked, in
France, if not in other countries, among the liberal and useful
sciences.
I am, &c.
 LETTER XXIV.
Versailles.—St. Cloud.—Sèvre.—Petit Trianon.—Specimen of an
extravagant bill.—Curious trial.—St. Germain.—Malmaison.—
Waterworks of Marly.

Paris, april 13th, 1802 (24 germinal).

my dear sir,
I went yesterday, with a small party of english friends, to Versailles,
and am just returned. I sit down now to give you the details of our
little excursion.
We stopped at St. Cloud, which is situate about half way, to view
that favourite palace of the unfortunate Lewis XVI, which will long be
celebrated in history, on account of the extraordinary meeting held
there by the council of five hundred, in the orangerie, or green
house, which ended in the establishment of the present consular
government.
St. Cloud is undergoing a thorough repair, previously to its being
inhabited by Bonaparte. It is difficult, therefore, to form a proper
estimate, either of what it formerly was, or of what it may become. I
do not suppose it ever could have been on a very large scale. The
gallery, which still remains, is a fine room, and the view is extensive
from the large window, by which it is terminated. The walls are
ornamented with some excellent paintings (I believe) by “le Brun.”
The chapel is now in a state of disorder, and I did not examine the
pictures which it contains. The garden has been neglected, and can
never have been either very extensive, or very beautiful. Formal
walks, and regular rows of trees, constitute all its merit. As to the
famous jets d’eau, or cascades, they are still in high preservation;
and the Parisians, on a particular day in every year, come here, in
splendid procession, to enjoy this favourite sight. I only saw
unmoved stone dragons, Neptunes, frogs, swans, and griffons, from
whose mouths these artificial waterfalls are vomited. In this state, at
least, a jet d’eau forms but a disagreeable ornament in a garden,
which ought to unite every beauty of nature, and to disdain every
other.
The next object to St. Cloud, which attracted our attention, was the
famous manufactory of Sèvre. The beautiful porcelain, which bears
the name of this town, continues to be made here, under the
immediate protection of the government. We visited the shop, or
magazin, and were shown the several rooms of which it consists. In
all of these were tables, covered with specimens of china made
here, but I cannot say that they answered my expectation. They
were neither as various, nor as splendid, as one should suppose
they would be, at the principal dépôt of so renowned a manufactory.
Probably, the situation in which France has been during the
revolution, did not afford a sufficient number of purchasers, to induce
the managers to keep by them any considerable quantity of
expensive articles. There were several busts of Bonaparte in
different sizes, all of which were strikingly resembling. There were
also great and small busts of Voltaire, Franklin, and Rousseau.
Going thence to Versailles, we drove to Rambrand’s, which is
esteemed the principal hotel; but finding, on our arrival, that the best
rooms were engaged, we changed our plan, and proceeded to le
Petit Trianon in the park, which, formerly the much loved retreat of
Marie Antoinette, has, in the strange metamorphosis things as well
as men have experienced in France, become a common inn.
Having ordered dinner to be prepared in a small room, once
celebrated as the luxurious boudoir of the ill fated queen, we
proceeded to view the curiosities of Versailles. The park has lost
some trees, and has been neglected. In other respects, it is not
much altered. The orangerie[63] still retains, unimpaired, all its
beauty. We walked through long avenues of orange trees, all of
which are in high health and rich foliage. The gardener assured us,
that some of those which were of very large dimensions, had been
planted in the reign of Francis I.
We next visited the private library of the former kings of France,
situate in a separate house in the town. There is nothing very
particular in the building; but there were, above the several doors of
the library, extremely pretty paintings of the different capitals of
Europe. We were here shown a very beautiful collection of
illuminated paintings, representing the splendid fête and
tournaments given by the magnificent Lewis XIV.
Thence our guide wished to take us to the national manufactory of
fire arms, which is carried on with great activity in this town; but
having seen many acknowledgedly superior works of the same kind
in England, we declined visiting it, and proceeded at once to the
palace. This superb building has not suffered at all during the
revolution; though, from being neglected and uninhabited, it has
contracted a kind of gloom, which forcibly recals the misfortunes of
its last possessors, and the uncertainty of human grandeur. The
magnificent furniture, which the apartments once contained, has
been removed; but the walls are not without ornament, for the palace
having been made (probably with the view of preserving it from
popular violence) a musée central, or dépôt of the works of art, now
possesses several valuable pictures, and a few excellent statues.
Among the former, I remarked some good Claude Loraines, and two
beautiful portraits by Vincent. The subject of one was Henry IV of
France; and the other, that of the celebrated president, Molé. The
latter is painted in his parliamentary robes, heroically exposing his
breast to the violence of the mob, and doing his duty, unmoved by
the poniards raised against him. You seem to hear him exclaim, as
history records he did, “La distance est grande de la main d’un
assassin au cœur d’un honnête homme[64].”
We walked through the vast suite of rooms, which, once the seat
of gayety, splendour, luxury, and royal magnificence, are now the
abode of solitude, and the monument of fallen grandeur.
It is unnecessary to state the many reflections which this spot
created. We failed not to visit the apartment which the unfortunate
Lewis XVI occupied on the 6th of october, and in which Marie
Antoinette took refuge. We were also shown the balcony window
(now stopped up), where that virtuous and ill fated princess,
madame Elizabeth, with a magnanimity truly heroic, presented
herself, when the queen was called for, and being taken for her,
voluntarily subjected herself to all the brutal violence of an irritated
mob.
We likewise saw the opera house, built for the wedding of Lewis
XVI, when dauphin, and which, during the last reign, was sometimes
used as a theatre, and sometimes as a ball room. The apartment is
still perfect, but the scenes and decorations have been removed.
On leaving the palace, we visited several jets d’eau; but were
prevented from viewing the garden as particularly as we could have
wished, a violent shower of rain having overtaken us.
The waterworks and pleasure grounds appear to have been much
neglected.
We dined at the Little Trianon, and slept there. The room, which
fell to my share, was that which the unhappy Lewis formerly
occupied, and the key of the door had attached to it a label, on which
could still be discovered, though half effaced, the words,
“appartement du roi[65].”
In calling for our bill this morning, we found that this little inn (ci-
devant a royal residence) had two proprietors, one of whom lets the
apartments, and the other supplies the table in the character of
“traiteur.” With the charges of the latter we had no fault to find; but
the demand of the former was so ridiculously exorbitant, that have
kept the bill as a curiosity, of which I add the copy.

Petit Trianon logement[66].

Francs.
Trois appartemens de maître 36
Bougie 6
Bois 9
Quatre lits de domestique 12
Total 63

By way of reconciling us to this extravagant charge, the mistress

of the house sent her daughter to us, a very pretty girl, with the bill.
Our gallantry, however, did not subdue our reason, and we
determined to resist the demand. Our hostess having indignantly
refused the half, which we offered as amply sufficient, Mr. ⸺ and I
proceeded to Versailles, in pursuit of a juge de paix. After being sent
to two or three justices, who told us, that it was not within their
jurisdiction, we at last, in a miserable lodging, and at an obscure
house, found the magistrate of the division. His dress and his
appearance were not superiour to his residence, and from these
united circumstances, we were far from expecting that justice which,
in the result, we experienced.
Having heard our case, he granted a citation, requiring the
attendance of the landlord; and, of course, suspended his decision
till the arrival of the other party. While our servant, who carried the
summons, went to execute it, we were present at a curious trial, the
subject of which was a small quantity, I believe a quart, of vinegar.
The defendant was a coarse masculine woman, at least sixty years
of age, who, when she had exhausted all her fund of eloquence,
burst into tears, and talked of the weak unprotected stare of an
unhappy widow. The plaintiff was a dirty ill looking fellow, with a
witness of no better appearance. They all talked together; and the
justice, instead of being able to moderate their violence, found it
difficult to gain a hearing himself. After a wrangle of an hour, and
after swearing and counterswearing to the same fact, they went
away, without the business being finally settled.
What entertained me much, was, that these disputants, in the
middle of their harangues, turned round to my friend and me, and
seemed anxious, each in his turn, to convince us, by their
eloquence, of the justice of their respective cases; though we were
not only strangers to the business, but also to the laws on which this
important question was to be decided.
When our good landlady arrived, her bill was produced; and the
justice having declared how exorbitant he thought it, she justified
herself on three grounds.
1st. That we had not made a previous agreement; and ergo, that
she had a right to demand whatever she pleased.
 2dly. That she paid a great rent “à la nation[67];” and that,
therefore, “la nation” ought to permit her to make her guests pay a
great rent for their lodgings.
3dly. That “l’ambassadeur de l’empereur Russe[68],” having lodged
at her house only a week before, and not having objected to a
charge of two louis per bed, “les milords anglois” ought to think her
present demand extremely reasonable.
Notwithstanding this very able defence, the justice told her, that
the law would not allow her d’écorcher les étrangers[69]; and very
equitably decreed, that we should pay 36 instead of 63 francs.
Madame received, very indignantly, the sum allotted her, and went
away in a rage, declaring that, in future, no person should sleep at le
petit Trianon, who would not bind himself before hand to pay the
price which “son excellence l’ambassadeur de toutes les Russies”
thought so reasonable.
So concluded our trial, which I have detailed as characteristic of
what is to be expected at inns in France, if prior arrangements be not
made by travellers; and likewise as an honourable proof, that justice,
though not clad in ermine, is fairly administered. In going away, I was
not a little surprised to find, that there were no costs to pay, and that
even the summons had been issued gratuitously.
In England, where we possess so admirable a system of laws,
how much are its advantages diminished, by the expenses attendant
on every process! for, as a distinguished public man once well
observed, though the temple of justice be open to all, it is like the
London tavern, only the favourites of fortune dare approach its
threshold.
In returning to our inn, we passed by the royal stables, which are
still kept up, and filled with horses. These are now appropriated to
the use of the officers of the army, who come here to be instructed in
the menage, and who employ, for this purpose, the quondam riding
school of the king. The horses appeared, at least to an english eye,
very indifferent. We also saw here some arabians, lately arrived from
Egypt. They are extremely plain, lanky, and awkward; but the groom
assured us, on being asked if they were swift, “Oui, monsieur,
comme les oiseaux.” (“Yes, sir, as swift as birds.”) It was in vain to
object to outward form, when we learnt that these animals had the
talent of flying. If, according to the old jockey phrase, “no good horse
can have a bad colour,” certainly no horse who flies can be ugly.
Before we left Versailles, we visited the garden of le petit Trianon,
which is rented by our honest landlady, and which may be seen, by
paying a small sum for a ticket at the gate. It is kept in tolerable
order, and has still strong marks of that good taste, with which it was
originally made. It is really, and not nominally, an english garden; and
would, even in our happy island, be deemed as prettily laid out, as
the smallness of its extent would permit.
The little theatre, built by the queen, situate within the precincts of
these grounds, is still in existence, and has suffered no loss,
excepting that of the beautiful glasses with which the boxes were
once splendidly illuminated. The last object, to which we were led at
Versailles, was “le grand Trianon,” that favourite spot of Lewis XVI.
This elegant building is also unhurt; and the fine marble pillars, which
form the entrance, excited all our admiration. The poverty, into which
the inhabitants of the town have fallen, in consequence of the
revolution, is strikingly apparent. In every corner, we were
surrounded by half-starved and half-naked beggars, whose
importunities were not a little troublesome.
In returning to Paris, we took the road of St. Germain. The old
castle still remains; but its outward appearance was so gloomy, that
we felt no inclination to visit the interiour. If the french monarch
intended to pay a compliment to the pretender, in giving him a palace
as nearly as possible resembling St. James’s, his choice was
admirable. The view from the terrace is pretty, but by no means
either as extensive, nor as rich, as I expected from its celebrity.
In continuing our road, we saw the celebrated waterworks of
Marly, which are preserved in all their perfection. We likewise passed
by the famous aqueduct, and by Malmaison, the private seat of the
first consul. The latter has nothing very particular to distinguish it. It
is simply a moderately sized house, situate near the river, but so low,
that it cannot command a very extensive prospect. I hear, the
grounds are well laid out, and that the furniture of the house unites
every thing which taste could order, or luxury afford. We reached
Paris about six o’clock; and my first employment, after dinner, has
been to write you this account, as I know that Versailles, and its
neighbourhood, are among the number of objects, about which
english curiosity is excited.
I am, &c.
 LETTER XXV.
Long Champ, account of that annual promenade, date of its origin, and of
the great preparations made this year for attending it.—The bustle,
and gayety which it produced at Paris.

Paris, april the 16th, 1802, (27 germinal).

my dear sir,
All Paris has been alive for the last three days. Can you guess the
reason? Perhaps you will imagine, that the inhabitants, roused from
the state of lethargy, into which they have for some time back been
plunged, are beginning to give sincere but tardy marks of joy, at the
reestablishment of internal order, and external peace. Not at all, my
good friend. A subject, much more interesting to the parisians, is the
cause of the show and gayety so generally exhibited. Know, then,
that “Long Champ” has begun! I must now, like other learned
commentators, explain my explanation.
“Long Champ” is the name of a village, situate on the other side of
the “Bois de Boulogne,” of which latter place I spoke to you in a
former letter. In this village stood an abbey, or church; and one of the
holy fathers, some hundred years ago, had a voice of such
extraordinary sweetness, that, when high mass was performed,
crowds of Parisians flocked to hear him. His popularity was not
confined to the lower class, and the noblesse shared the curiosity of
the public. The fashion of going to Long Champ so rapidly increased,
that, in a short time, it was no uncommon thing to see whole strings
of splendid carriages at the door of the convent. The road to this
village became the favourite ride, and vanity soon discovered, that it
afforded an excellent opportunity of displaying all the varieties of
dress, and all the pomp of equipage. In the course of a few years, it
became an established custom, at this particular period of the year,
to make, during three days, not an humble pilgrimage, but a splendid
procession, to Long Champ. The mass and the singer were soon
forgotten; but the promenade continued, and increased every year in
the magnificence of parade. To appear, on this occasion, with
becoming grandeur, the haughty, but often distressed noble, would,
for months beforehand, deprive himself of his ordinary comforts. To
rival “les dames de bonne compagnie[70]” in richness of dress, in
show of equipage, and blaze of diamonds, was the grand object of
the admired belles of the opera house; and the means of doing so,
was the exacted price of those smiles, which the well beneficed
prelate, or the wealthy financier, were sometimes permitted to enjoy.
The Bourgeois and their wives appeared in their humble cabriolets,
but the former wore their Sunday apparel; and the latter were loaded
with all the tinsel finery, which, during the course of the year, they
had been able to collect. The common people, or la canaille (as they
were then indignantly called), were equally fond of this procession;
and, at the risk of being run over, crowded and completed the show,
some dressed in tattered regimentals, some in faded silk coats, and
ragged embroidered waistcoats, and others with bag-wig’s and
wooden shoes.
Such was the custom during “l’ancien régime.” The amusements
of the french vanished with their old political institutions, and
“horrendum dictu,” Long Champ was long unobserved.
Robespierre, and after him the directors, forbade every thing
which bore the least resemblance to the customs of former times;
but when Bonaparte came into power, the system was instantly
changed, and the people, left to follow their own inclinations, greedily
returned to all their former diversions. “Long Champ” was of the
number; and, since the 18th of brumaire, it has been gradually
recovering its ancient magnificence. This year, from the
reestablishment of peace, and the confluence of foreigners, it was
expected to be finer than ever; and vast preparations have, during
some weeks past, been making. Milliners tortured their fancy to
invent new fashions; mantuamakers passed whole nights without
sleep, in executing the orders which they had received;
coachmakers exerted themselves with all the art of their trade, and
all the vanity of their country, in endeavouring to imitate the carriages
of the english; horses were sent for from every part of the world;
regiments of tailors were employed in making coats for the beaux,
habits for the ladies, and laced jackets for their grooms; strings of
boots were seen dangling on the backs of porters in every quarter of
the town; saddles were as much in requisition, as if a great military
project, by the means of cavalry, had been in agitation; and I have
been confidently assured, that no less than three thousand pair of
leather breeches were ordered on the occasion.
In consequence of these active preparations, and of “Long
Champ” having been, for some weeks back, infinitely more the
subject of conversation than either the peace, or the reestablishment
of religion, I expected, at least, a very brilliant sight. I must say, I was
disappointed. The only thing which pleased me very much, was the
bustle which it produced in the town, and the gayety with which it
animated the faces of the Parisians. For three days, every vehicle in
the shape of a carriage, and every animal which claimed the name of
horse, has been dragged into use, and become part of the
procession. About two o’clock, a military guard was posted at the
beginning of the Champs Elisées, to preserve order, (for nothing
here is done without soldiers); and from that hour, till some time after
sunset, the crowd gradually increased. At three, the line of carriages
reached from “la place de la Concorde” to the “Bois de Boulogne;”
and, of course, there were frequent stoppages, even at the
beginning of the promenade. The road not employed in this manner,
was filled with equestrians of all ranks, and the walk on both sides
was equally thronged with passengers on foot. There were some few
elegant english equipages, well appointed, and others spoiled, by
the shabby appearance of the servants, or the extreme badness of
the horses. The french coachmakers, in one or two instances,
successfully imitated the fashions of London; but, generally
speaking, the attempt only served to prove the vast distance which
exists, between the two countries, in the art of constructing
carriages.
Mixed with “les voitures à l’anglaise, ou véritablement
anglaises[71]” were seen old fashioned berlins, family coaches, and
superannuated cabriolets of all descriptions. Phaetons, gigs,
curricles, and whiskies, completed the procession. Among the
horsemen were seen a few returned emigrants, who had so well
copied the dress of our young men of ton, that they might have been
mistaken for the beaux of Bond street; but the greater number
(malgré their leather breeches and boots, their blue frocks and high
crowned hats) betrayed the forgery, by the preposterous addition of
ear-rings, coloured capes, or pointed toes. The ladies appeared in
every variety of clothing. Some, who ventured to be their own
charioteers, assumed the neat and appropriate dress of an
“amazone,” or habit. Others, decorating, and concealing as little as
possible, the charms of their person, shone in all the brilliance of
their evening apparel. Worked gowns, laced caps, and showy
turbans, were sometimes exhibited from the windows of hackney
coaches; and a dirty buggy had, not unfrequently, the honour of
conveying three or four damsels, whose costume would not have
been unsuited to the first heroine of the stage. It is impossible to
describe, or convey, the faintest idea of the grotesque figures which
appeared on this occasion; and, notwithstanding the trouble and
expense to which so many individuals had exposed themselves, by
the purchase of new carriages, new liveries, new horses, new
dresses, and last, not least, new leather breeches, the whole
appeared to me but a shabby exhibition, dull amusement.
Moving, in slow procession, to the other side of the Bois de
Boulogne, during five or six hours, constituted the whole pleasure of
this vaunted fête. There were certainly some elegant carriages, and
some handsome horses; but the number was too inconsiderable to
make amends for the crowd of those of a contrary description.
Nothing could be more tiresome than sitting in one of these vehicles,
as they were compelled, every instant, to stop, on account of the
lengthened line, which increased every moment. Persons on
horseback were equally ill off, as it required the utmost care to avoid
being driven against the wheels of the carriages; and as for the
pedestrians, they were almost buried in a volley of dust.
Such is the celebrated promenade of Long Champ, which, though
an annual festival, appears to me a wretched and pitiful imitation of
Hyde park on an ordinary sunday. Yet the french are delighted with
their amusement; and in returning this evening, I heard on every
side, “Quel beau spectacle! quelles jolies voitures! quels magnifiques
chevaux! quelle belle parure! Vraiment c’est charmant[72]!”
It is not a little flattering to the vanity of an englishman, to see how
rapidly the french are adopting our fashions; and, notwithstanding
the awkward manner in which they are sometimes copied, yet such
is the general bias, that I entertain no doubt that, in the space of ten
years, (if the peace should last so long), it will become almost
impossible to distinguish, by his dress, a native of France from one
of England.
The ladies of Paris, and those of London, differ, indeed, very
widely in their toilet. Perhaps they might reciprocally improve by
observing each other; and while the former would do right to respect
and imitate the modesty, with which the latter are usually clad, our
fair countrywomen might also, without any injury to their beauty, or
any violation of that delicacy, which is their brightest ornament, adopt
some of that taste, elegance, and fancy, which are often seen in the
dress of a well bred frenchwoman.
Adieu, my dear sir. I am heartily tired of my subject, and fear you
will have been so some time. I therefore take my leave for the
present.
I am, &c.
 LETTER XXVI.
Te Deum sung at Notre Dame, in honour of the peace and the
reestablishment of religion.—Military insolence.—Account of the
ceremony.—Illuminations in the evening.—Indifference of the people.

Paris, april the 18th, 1802, Easter Sunday (28 germinal.)

my dear sir,
To day will probably be long remembered in the annals of France, on
account of the promulgation of the law for (“l’établissement des
cultes”) the reestablishment of religion; on account of the definitive
treaty of peace with England, the ratifications of which were
exchanged this morning at the Thuilleries; and of the “Te Deum”
sung at Notre Dame, in honour of these united events.
I wished very much to be present at a ceremony, which was
rendered so particularly interesting by the number of curious
concurring circumstances, too obvious to be detailed. Having no
ticket, I went to the church at six o’clock in the morning, hoping to
make my way, among the crowd, into those places, which were not
appropriated to the constituted authorities. The doors were not open;
and about a hundred persons, who were already arrived, stood
enclosed in a kind of barrier, which seemed to have been put up for
the purpose of preventing too great a press at the first opening of the
gates. I placed myself against this bar, and hoped to gain admittance
in the second division. I was soon followed and surrounded by a
considerable crowd; and, after we had all remained about two hours
in this uncomfortable state, a detachment of soldiers arrived, and
attempted instantly to clear a passage. We were already so
squeezed together, that it was impossible to make room for the
military, without either losing our places, or incurring the danger of
suffocation. When the soldiers perceived that, notwithstanding the
blows which they dealt around them without ceremony, the people
did not immediately make way, they lost all patience; and, not
content with fixing their bayonets, called out for a detachment of
horse. The brandishing of the one, and the fear of the other, soon
dispersed the mob; but not till some had been wounded, and several
severely bruised.
I could not help reflecting, with some degree of indignation, on this
singular scene. In England, under a monarchical form of
government, the military are not allowed to interfere, but in cases of
positive danger, or actual insurrection; and even then under the
orders of a civil magistrate. In France, where the system is called
“republican,” and every man supposed to constitute a part of the
sovereignty, the body of the people, coming quietly to see the first
solemn service of that religion, which is said to be restored in
compliance with their wishes, are driven with blows and military
violence from the doors of that church, in which peace, liberty,
equality, and good order, are about to be celebrated. Perhaps,
indeed, it may be urged, that this was only a necessary precaution of
the police, and that the object of the guard was to prevent that riot
and danger to which the public, not so protected, would have been
exposed. The answer is plain. If it was thought necessary to maintain
order by the assistance of the military power, the sentinels ought to
have been placed the preceding night, or at the dawn of morning. It
was adding insult to cruelty, to permit the people to assemble, and
after the loss of several hours, and the endurance of great fatigue, to
dismiss them in the manner I have described.
It is needless for me to say, that I soon relinquished all hope of
getting into the church, and thought myself happy in being able to
make my escape unhurt from the claws of these heroes.
In going away, I perceived at the window of an adjoining hospital,
nearly opposite the church, some ladies of my acquaintance, who
were so obliging as to offer me a place near them, from which I
might see the procession.
I had scarcely taken this situation, when a ticket for one of the
privileged places in the church was given me by a person, who was
unwilling to risk the difficulties, with which the approach to the doors
seemed attended. After being sent about to different gates, I at last
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