A two‐mean reverting‐factor model of the term structure of interest rates

Abstract

The term structure of interest rates for default-free discount bonds has been a topic covered in many papers. As a rst approximation to its analysis, onefactor models were developed. These models assume that the movements of the yield curve are determined by a single state variable. This state variable is usually the instantaneous riskless interest rate and is modeled as a di usion process. Examples of these models are Vasicek (1977), Dothan (1978) and Cox, Ingersoll and Ross (hereafter CIR) (1985b). An empirical comparison

Modelling the term structure of interest rates: An efficient nonparametric approach

“…This study could also be extended to models with two or more risk factors, that is the interest rate and his volatility Longstaff and Schwartz (1992), or the long-term interest rate and the spread Moreno (2003). Singh (1995), Rebonato (1996), Navarro and Nave (1997) and Soto (2004) establish that three factors would explain almost the entire variance of interest rate changes.…”

Improving the term structure of interest rates: two‐factor models

“…Examples of state variables that verify the condition in Remark 1 are the long rate (l) and the spread between the short rate and the long rate (s 5 rÀl). These factors have been considered by Schaefer and Schwartz (2004), Moreno (2003) and Knight et al (2006). Richard (1978) assumes that the nominal interest rate is the sum of the real interest rate and the rate of inflation.…”

Do We Need to Worry about Credit Risk Correlation?

“…The solution of the previous PDE is given (Moreno [2003]) by where If t is a linear combination of I independent state variables, , the price of a zero-coupon bond (2) can be expressed as…”