Term Structure: Interest Rate Models

Thomas S. Y. Ho () and Sang Bin Lee
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Thomas S. Y. Ho: Thomas Ho Company, Ltd.
Sang Bin Lee: Hanyang University

Chapter 25 in Encyclopedia of Finance, 2022, pp 819-833 from Springer

Abstract: Abstract Interest movement models are important to financial modeling because they can be used for valuing any financial instruments whose values are affected by interest rate movements. Specifically, we can classify the interest rate movement models into two categories: equilibrium models and no-arbitrage models. The equilibrium models emphasize the equilibrium concept. However, the no-arbitrage models argue that the term-structure movements should satisfy the no-arbitrage condition. The arbitrage-free interest rate model is an extension of the Black–Scholes model to value interest rate derivatives. The model valuation is assured to be consistent with the observed yield curve in valuing interest rate derivatives and providing accurate pricing of interest rate contingent claims. Therefore, it is widely used for portfolio management and other capital market activities.

Keywords: Black; Derman; and Toy model; Brennan and Schwartz two-factor model; Cox; Ingersoll and Ross model; Ho and Lee model; Hull and White model; Interest correlation; Lognormal versus normal movements; Mean reversion; Term structure volatility; Vasicek model (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/978-3-030-91231-4_64

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