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Numerical integration of mean reverting stochastic systems with applications to interest rate term structure simulation

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  • William Morokoff

Abstract

A proof of convergence is presented for a simplified numerical integration method for solving systems of correlated stochastic differential equations describing mean reverting geometric Brownian motion. Such systems arise in modelling the time evolution of interest rate term structures. For time discretization of size Δt, the method leads to global error in time of O (Δt2) and no error accumulation. The result is shown to extend to the case when principal components analysis is used to reduce the number of underlying stochastic factors.

Suggested Citation

  • William Morokoff, 1999. "Numerical integration of mean reverting stochastic systems with applications to interest rate term structure simulation," Applied Mathematical Finance, Taylor & Francis Journals, vol. 6(1), pages 19-28.
    • Handle: RePEc:taf:apmtfi:v:6:y:1999:i:1:p:19-28
    DOI: 10.1080/135048699334591
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    References listed on IDEAS

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    1. Dothan, L. Uri, 1978. "On the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 6(1), pages 59-69, March.
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