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A Binomial Basis for the Cox, Ingersoll and Ross Model of the Term Structure of Interest Rates

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  • Huw Rhys
  • Mark Tippet

Abstract

The technical demands of the Cox, Ingersoll and Ross (1985a and 1985b) papers are such that they can only be mastered by those who have a good understanding of some deep mathematics and statistical concepts, including the techniques of continuous time stochastic calculus and the measure theory upon which it is based, the Kuhn‐Tucker theory surrounding non‐linear optimisation techniques as well as variational methods founded on solutions of non‐linear differential equations. Hence, our purpose here is to formalise both investor preferences and the supply side which underscores the Cox, Ingersoll and Ross (1985b) ‘square root’ model of the term structure of interest rates in terms of some simple binomial filtration processes, thereby avoiding most of the intricate technical detail contained in the original papers. These procedures not only allow for a more focused evaluation of the model's underlying strengths and weaknesses but also provide a framework for assessing some of the strategies which the model makes available for hedging exposure against adverse interest rate movements.

Suggested Citation

  • Huw Rhys & Mark Tippet, 2001. "A Binomial Basis for the Cox, Ingersoll and Ross Model of the Term Structure of Interest Rates," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 28(3‐4), pages 379-405, April.
    • Handle: RePEc:bla:jbfnac:v:28:y:2001:i:3-4:p:379-405
    DOI: 10.1111/1468-5957.00378
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    Cited by:

    1. Clark, Ephraim & Lakshmi, Geeta, 2007. "Assymetric information and the pricing of sovereign eurobonds: India 1990-1992," Global Finance Journal, Elsevier, vol. 18(1), pages 124-142.
    2. Qian Guo & Huw Rhys & Xiaojing Song & Mark Tippett, 2016. "The Friedman rule and inflation targeting," The European Journal of Finance, Taylor & Francis Journals, vol. 22(14), pages 1414-1434, November.
    3. Paul Klumpes & Mark Tippett, 2004. "A Modified ‘Square Root’ Process for Determining the Value of the Option to (Dis)invest," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 31(9‐10), pages 1449-1481, November.

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