4.4 Conclusion


4.4 Conclusion

In developing a two factor model, LS overcome one of the most frequently cited criticisms of one factor models: the perfect correlation of instantaneous returns on bonds of all maturities. The model produces closed-form option prices for the case of stochastic volatility; this is a highly desirable feature few other models can produce. Additionally, the very flexible functional form of the model allows for very complicated shapes of the yield curve to be obtained with relative ease. However, this flexible functional form makes calibration rather difficult. The flexible functionality allows almost any market- observed term structure to be fitted, but this does not necessarily ensure meaningful term structure dynamics. One of the inevitable side effects of increasing the numbers of factors is the increased complexity; here, pricing of a simple European option requires evaluation of the bivariate non-central chi-square distribution.




Interest Rate Modelling
Interest Rate Modelling (Finance and Capital Markets Series)
ISBN: 1403934703
EAN: 2147483647
Year: 2004
Pages: 132

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