Transcription of Term Structure Models: IEOR E4710 Spring 2010 …
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Term Structure Models: IEOR E4710 Spring 2010 …
Term Structure Models: IEOR E4710 Spring 2010c 2010 by Martin HaughMarket ModelsOne of the principal disadvantages of short rate models, and HJM models more generally, is that they focus onunobservable instantaneous interest rates. The so-called market models that were developed1in the late90 sovercome this problem by directly modeling observable market rates such as LIBOR2and swap rates. Thesemodels are straightforward to calibrate and have quickly gained widespread acceptance from practitioners. Thefirst market models were actually developed in the HJM framework where the dynamics of instantaneous forwardrates are used via It o s Lemma to determine the dynamics of zero-coupon bonds. The dynamics of zero couponbond prices were then used, again via It o s Lemma, to determine the dynamics of LIBOR. Market models aretherefore not inconsistent with HJM models. In these lecture notes, however, we will prefer to specify themarket models directly rather than derive them in the HJM framework.
Term Structure Models: IEOR E4710 Spring 2010 °c 2010 by Martin Haugh Market Models One of the principal disadvantages of short rate models, and HJM models more generally, is that they focus on
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