Economics: Current and Future Developments

Economics: Current and Future Developments

Volume: 1

Interest Rate Modeling for Risk Management: Market Price of Interest Rate Risk

Indexed in: Book Citation Index, Social Sciences & Humanities.

Interest Rate Modeling for Risk Management introduces a theoretical framework - the ‘real-world’ model - that allows us to estimate the market price of interest rate risk based on practical and ...
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Real-World Model in The Hull-White Model

Pp. 165-184 (20)

Takashi Yasuoka

Abstract

This chapter studies construction of a Hull-White-type real-world model, using the results of Section 6 to do so.

First, we briefly summarize some approaches to volatility estimation in the short rate model. Next, we present two methods for calibrating the Hull-White model. One is to analyze the short rate dynamics. The other is to analyze the forward rate dynamics, working within the HJM framework. Additionally, we remark on some practical aspects of volatility estimation with respect to the mean reversion rate.

Accordingly, we present a method for constructing a Hull-White model under the real-world measure. The chief benefit of this is that the real-world Hull-White model is simple to compute; Section 8.6 summarizes the numerical procedures necessary to construct the real-world model. Further, some numerical examples will be presented in Chapter 10.

Keywords:

Historical volatility, Hull-White model, Hull-White volatility, Humped volatility, Implied volatility, Market price of risk, Mean reversion, Monte Carlo simulation, Negative mean reversion, Nelson-Siegel model, Norminvariant condition, Numerical procedure, One-factor model, Principal component analysis, Real-world model, Risk-neutral model, Rolled trend score, short rate model, Volatility estimation.

Affiliation:

Graduate School of Engineering Management, Shibaura Institute of Technology. 3-9-14 Shibaura, Minato-ku, Tokyo.