Question #23
Reading: Reading 26 The Arbitrage-Free Valuation Framework
PDF File: Reading 26 The Arbitrage-Free Valuation Framework.pdf
Page: 11
Status: Correct
Correct Answer: A
Question
Currently the term structure of interest rate is downward sloping. Which of the following models most accurately describe the current term structure?
Answer Choices:
A. Vasicek model
B. Cox-Ingersoll-Ross model
C. Ho-Lee model
Explanation
Ho-Lee model is an arbitrage-free term structure that is calibrated to the current actual
term structure (regardless of whether it is upward or downward sloping). Vasicek and Cox-
Ingersoll-Ross model are examples of equilibrium term structure models and may
generate term structures inconsistent with current market observations.