Articles

A General Stochastic Volatility Model for the Pricing of Interest Rate Derivatives

A. TROLLE, S. E. SCHWARTZ

Review of Financial Studies

2009, vol. 22, n°5, pp.2007-2057

Départements : Finance

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.532.9852&rep=rep1&type=pdf


We develop a tractable and flexible stochastic volatility multifactor model of the term structure of interest rates. It features unspanned stochastic volatility factors, correlation between innovations to forward rates and their volatilities, quasi-analytical prices of zerocoupon bond options, and dynamics of the forward rate curve, under both the actual and risk-neutral measures, in terms of a finite-dimensional affine state vector. The model has a very good fit to an extensive panel dataset of interest rates, swaptions, and caps. In particular, the model matches the implied cap skews and the dynamics of implied volatilities


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