IDEAS home Printed from https://ideas.repec.org/a/wly/jfutmk/v23y2003i11p1075-1105.html
   My bibliography  Save this article

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

Author

Listed:
  • Manuel Moreno

Abstract

This article presents a two‐factor model of the term structure of interest rates. It is assumed that default‐free discount bond prices are determined by the time to maturity and two factors, the long‐term interest rate, and the spread (i.e., the difference) between the short‐term (instantaneous) risk‐free rate of interest and the long‐term rate. Assuming that both factors follow a joint Ornstein‐Uhlenbeck process, a general bond pricing equation is derived. Closed‐form expressions for prices of bonds and interest rate derivatives are obtained. The analytical formula for derivatives is applied to price European options on discount bonds and more complex types of options. Finally, empirical evidence of the model's performance in comparison with an alternative two‐factor (Vasicek‐CIR) model is presented. The findings show that both models exhibit a similar behavior for the shortest maturities. However, importantly, the results demonstrate that modeling the volatility in the long‐term rate process can help to fit the observed data, and can improve the prediction of the future movements in medium‐ and long‐term interest rates. So it is not so clear which is the best model to be used. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23: 1075–1105, 2003

Suggested Citation

  • Manuel Moreno, 2003. "A two‐mean reverting‐factor model of the term structure of interest rates," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 23(11), pages 1075-1105, November.
  • Handle: RePEc:wly:jfutmk:v:23:y:2003:i:11:p:1075-1105
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/
    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. Fernando Rubio, 2004. "Eficiencia Simple Del Mercado De Renta Fija En Chile," Finance 0405009, University Library of Munich, Germany.
    2. Tarik Bazgour & Federico Platania, 2022. "A defaultable bond model with cyclical fluctuations in the spread process," Annals of Operations Research, Springer, vol. 312(2), pages 647-672, May.
    3. 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.

    More about this item

    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

    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:wly:jfutmk:v:23:y:2003:i:11:p:1075-1105. See general information about how to correct material in RePEc.

    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 bibliographic 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.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: http://www.interscience.wiley.com/jpages/0270-7314/ .

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

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.