Abstract: Interest rate models are essentially a description of the short-term rate in terms of a stochastic process. The key assumption made in a one-factor model is that all interest rates move in the same direction. It is possible to model the entire forward rate curve as a function of the current short rate only, in the Vasicek and Cox-Ingersoll-Ross models, among others. The Hull-White model is an extension of the Vasicek model designed to produce a precise fit with the current term structure of rates. Both the Vasicek and Merton models assume constant parameters, and because of equal probabilities of forward rates and the assumption of a normal distribution, they can, under certain conditions relating to the level of the standard deviation, produce negative forward rates. The equilibrium models can be converted into arbitrage-free models by making the short rate drift rate time dependent.
Publication Year: 2019
Publication Date: 2019-04-14
Language: en
Type: other
Indexed In: ['crossref']
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