Paper #193

Título:

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

Autor:

Manuel Moreno

Data:

Noviembre 1996

Resumen:

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.

Palabras clave:

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

Códigos JEL:

C51, E43, G13

Área de investigación:

Finanzas y Contabilidad

Publicado en:

Journal of Futures Markets, 23, 11, 1075-1105, 2003

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