9.4 Conclusion


9.4 Conclusion

In a simple and concise extension of the BDT model, BK are able to eliminate one of its most frequently cited shortcomings - the direct but artificial link between the current volatility term structure and future values of short-term interest rate volatility. BK introduce a third time-dependent variable, reversion speed, which allows an additional degree of freedom. Now the interest rate and volatility term structures as well as cap prices can be included in the calibration procedure.

Empirical results of calibration exercises for this model are not widely available. However, based on results of other models [1] attempting to include all three term structures (interest rate, volatility and cap prices), one could suspect an over-parameterisation may result, with future volatility term structures taking on unreasonable shapes .

[1] For example the extended-Vasicek Hull White model discussed in Chapter 7.




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

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