Dynamics of the term structure on interest rates: a two-factor model
AbstractThe 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.
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Bibliographic InfoPaper provided by Universitat de Barcelona. Espai de Recerca en Economia in its series Working Papers in Economics with number 37.
Length: 0 pages
Date of creation: 1998
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Postal: Espai de Recerca en Economia, Facultat de CiÃ¨ncies EconÃ²miques. Tinent Coronel Valenzuela, Num 1-11 08034 Barcelona. Spain.
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