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Interest rate trees: extensions and applications

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  • John Hull
  • Alan White

Abstract

This paper provides extensions to existing procedures for representing one-factor no-arbitrage models of the short rate in the form of a tree. It allows a wide range of drift functions for the short rate to be used in conjunction with a wide range of volatility assumptions. It shows that, if the market price of risk is a function only of the short rate and time, a single tree with two sets of probabilities on branches can be used to represent rate moves in both the real-world and risk-neutral world. Examples are given to illustrate how the extensions can provide modelling flexibility when interest rates are negative.

Suggested Citation

  • John Hull & Alan White, 2018. "Interest rate trees: extensions and applications," Quantitative Finance, Taylor & Francis Journals, vol. 18(7), pages 1199-1209, July.
    • Handle: RePEc:taf:quantf:v:18:y:2018:i:7:p:1199-1209
    DOI: 10.1080/14697688.2017.1406131
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    Cited by:

    1. Kladívko, Kamil & Rusý, Tomáš, 2023. "Maximum likelihood estimation of the Hull–White model," Journal of Empirical Finance, Elsevier, vol. 70(C), pages 227-247.

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