Work

A General Stochastic Volatility Model for the Pricing and Forecasting of Interest Rate Derivatives

Year: 2006

Type: report

Abstract: We develop a tractable and flexible stochastic volatility multi-factor model of the term structure of interest rates.It features correlations between innovations to forward rates and volatilities, quasi-analytical prices of zero-coupon bond options and dynamics of the forward rate curve, under both the actual and risk-neutral measure, in terms of a finite-dimensional affine state vector.The model has a very good fit to an extensive panel data set of interest rates, swaptions and caps.In particular, the model matches the implied cap skews and the dynamics of implied volatilities.The model also performs well in forecasting interest rates and derivatives.

Source: National Bureau of Economic Research

DOI: 10.3386/w12337

Authors: Anders Trolle, Eduardo Schwartz

Institutions: University of California, Los Angeles, Copenhagen Business School

Language: English

Topic: Stochastic processes and financial applications

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: green

OpenAlex ID: W2148208334

Cites: 38

Cited by: 10

Related to: 10