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Equilibrium Short-Rate Models Vs No-Arbitrage Models: Literature Review and Computational Examples

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  • Josheski Dushko

    (Business Administration, University Goce Delchev, Stip, Macedonia)

  • Apostolov Mico

    (Business Administration, University Goce Delchev, Stip, Macedonia)

Abstract

In this paper equilibrium short-rate models are compared against no-arbitrage short-rate models. This article is composed of the introduction to this literature and a review, followed by numerical examples of one-factor short-rate models; the Cox-Ingersoll-Ross (CIR) model and the Vasicek model. No-arbitrage models were presented through the Hull-White (HW) model, the Binomial lattice model for bond pricing and interest rate modelling, the Black-Karasinski (BK) model, and the Heath-Jarrow-Morton (HJM) model. The results prove that no single interest rate model exists that can be used for all purposes. These models were compared in terms of volatility, mean reversion process and convergence. The end results confirm the dependence of volatility on the level rate as a determinant of the predictive success of these models.

Suggested Citation

  • Josheski Dushko & Apostolov Mico, 2021. "Equilibrium Short-Rate Models Vs No-Arbitrage Models: Literature Review and Computational Examples," Econometrics. Advances in Applied Data Analysis, Sciendo, vol. 25(3), pages 42-71, September.
    • Handle: RePEc:vrs:eaiada:v:25:y:2021:i:3:p:42-71:n:4
    DOI: 10.15611/eada.2021.3.03
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    References listed on IDEAS

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    More about this item

    Keywords

    equilibrium models; one factor short-rate models; no-arbitrage models; Vasicek model; Hull-White (HW) model; Black-Karasinski (BK) model; Heath-Jarrow-Morton (HJM) model; Cox-Ingersoll-Ross (CIR) model;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications

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