An Arbitrage-free Two-factor Model of the Term Structure of Interest Rates: A Multivariate Binomial Approach (original) (raw)

1998

Abstract

We build a no-arbitrage model of the term structure, using two stochastic factors on each date, the short-term interest rate and the forward premium. The model is essentially an extension to two factors of the lognormal interest rate model of Black-Karazinski. It allows for mean reversion in the short rate and in the forward premium. The method is computationally efficient

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