Dynamics of the term structure on interest rates: a two-factor model

Hortensia Fontanals Albiol, Merche Galisteo and Lourdes Gomez del Valle
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Lourdes Gomez del Valle: Universitat de Barcelona

No 37, Working Papers in Economics from Universitat de Barcelona. Espai de Recerca en Economia

Abstract: The main goal of this paper is to develop a model of the term structure of interest rates, based on a Black-Sholes type of arbitrage and study its properties. In order to achieve this objective two state variables are considered: the long-term interest rate l(t), and the spread (difference between the instantaneous and the long-term interest rat), s(t). These two state variables have been previously considered by other researchers: Shaefer and Schwartz (1984) and Moreno (1997). The main differences of this paper from Schaefer and Schwartz's consist on defining l(t) as the long-term interest rate (Schaefer and Schwartz used the consol rate). As a result, the market price of risk associated to this variable is an exogenous parameter of the model. In comparison to Moreno's in this paper the long-term interest rate follows a square root process which does not allow negative rates and the volatility is sensitive to the variations of the process.

JEL-codes: G13 (search for similar items in EconPapers)
Pages: 0 pages
Date: 1998
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Persistent link: https://EconPapers.repec.org/RePEc:bar:bedcje:199837

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