Question #25
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
Jill Sebelius, editor-in-chief of a monthly interest-rate newsletter uses the following model to forecast short-term interest rates: For the current newsletter, Sebelius has issued the following expectations: a=0.40, b = 3%, r = 2%. Sebelius's model is most accurately described as the:
Answer Choices:
A. Vasicek model
B. Ho-Lee model
C. Cox-Ingersoll-Ross model. dr = a(b −r) dt + σ√rdz
Explanation
The model given is an example of the Cox-Ingersoll-Ross model which differs from the
Vasicek model by including the square root of current level of short-term interest rates in
the stochastic part of the equation.
(Module 26.3, LOS 26.i)
dr = a(b −r) dt + σ√rdz