Types of Interest Rate Models in Fixed Income Valuation
In fixed income valuation, interest rate models play a pivotal role in determining the fair value of bonds and other interest rate-sensitive securities. These models simulate the dynamic behavior of interest rates, providing insights into future rate movements and their impact on bond prices.
1. Short-Rate Models:
Vasicek Model: Assumes a mean-reverting short-term interest rate that follows a Gaussian process. It is widely used for valuing short-term bonds and interest rate derivatives.
Cox-Ingersoll-Ross (CIR) Model: Similar to Vasicek but allows for negative interest rates. It is suitable for modeling long-term interest rates and interest rate caps.
2. Term-Structure Models:
Hull-White Model: Models the instantaneous forward r....
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