A User's Guide to Interest Rate Models: Applications for Structured Finance

Abstract

The advent of derivatives and structured products has coincided with a proliferation of fixed income models used to analyze hedging, pricing, forecasting, and estimation for the term structure of interest rates. This article evaluates five models Ho‐Lee (HL); Black‐Derman‐Toy (BDT); Vasicek; Cox‐Ingersoll‐Ross (CIR); and Heath‐Jarrow‐Morton (HJM) (see Exhibit 1) that are currently used by structured finance practitioners. We suggest which models are most appropriate for assets with different time horizons, interest rate sensitivities and cashflow properties. The authors link model selection to structured financial instruments with the singular focus on the trade‐off between model precision/complexity and calculation costs.

Citation

PAUL JOSHI, J. and SWERTLOFF, L. (1999), "A User's Guide to Interest Rate Models: Applications for Structured Finance", Journal of Risk Finance, Vol. 1 No. 1, pp. 106-114. https://doi.org/10.1108/eb022940