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Taking arbitrage opportunities into consideration in an incomplete market, dealers will price bonds based on asymmetric information. The dealer with the best offering price wins the bid. The risk premium in dealer's offering price is primarily determined by the dealer's add-on rate of change to the term structure. To optimize the trading strategy, a new equilibrium trading model is introduced. Optimal sequential estimation scheme for detecting the risk premium due to private inforamtion is proposed based on historical prices, and the best bond pricing formula is given with the according optimal trading strategy. Numerical examples are provided to illustrate the economic insights under the certain stochastic term structure interest rate models.
Bao et al. (Mon,) studied this question.