IDEAS home Printed from https://ideas.repec.org/p/upf/upfgen/193.html
   My bibliography  Save this paper

A two-mean reverting-factor model of the term structure of interest rates

Author

Listed:
  • Manuel Moreno

Abstract

This paper presents a two--factor model of the term structure of interest rates. We assume that default free discount bond prices are determined by the time to maturity and two factors, the long--term interest rate and the spread (difference between the long--term rate and the short--term (instantaneous) riskless rate). Assuming that both factors follow a joint Ornstein--Uhlenbeck process, a general bond pricing equation is derived. We obtain a closed--form expression for bond prices and examine its implications for the term structure of interest rates. We also derive a closed--form solution for interest rate derivatives prices. This expression is applied to price European options on discount bonds and more complex types of options. Finally, empirical evidence of the model's performance is presented.

Suggested Citation

  • Manuel Moreno, 1996. "A two-mean reverting-factor model of the term structure of interest rates," Economics Working Papers 193, Department of Economics and Business, Universitat Pompeu Fabra.
  • Handle: RePEc:upf:upfgen:193
    as

    Download full text from publisher

    File URL: https://econ-papers.upf.edu/papers/193.pdf
    File Function: Whole Paper
    Download Restriction: no

    Other versions of this item:

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Lourdes Gómez-Valle & Julia Martínez-Rodríguez, 2010. "Improving the term structure of interest rates: two-factor models," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(3), pages 275-287.
    2. Fernando Rubio, 2004. "Eficiencia Simple Del Mercado De Renta Fija En Chile," Finance 0405009, EconWPA.

    More about this item

    Keywords

    Term structure of interest rates; bond pricing equation; two--factor models; Ornstein--Uhlenbeck processes; interest rate derivatives;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:upf:upfgen:193. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: http://www.econ.upf.edu/ .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.