Modelling Interest Rates by Correlated Multi-Factor CIR-Like Processes

23 Pages Posted: 29 Jul 2008 Last revised: 31 Jul 2008

See all articles by Lorenzo Bertini

Lorenzo Bertini

Sapienza University of Rome

Luca Passalacqua

La Sapienza, University of Rome

Date Written: July 24, 2008

Abstract

We investigate the joint description of the interest-rate term stuctures of Italy and an AAA-rated European country by mean of a - here proposed - correlated CIR-like bivariate model where one of the state variables is interpreted as a benchmark risk-free rate and the other as a credit spread. The model is constructed by requiring the strict positivity of interest rates and the asymptotic decoupling of the joint distribution of the two state variables on a long time horizon. The second condition is met by imposing the reversibility of the process with respect to a product measure, the first is then implemented by using the tools of potential theory. It turns out that these conditions select a class of non-affine models, out of which we choose one that is quadratic in the two state variables both in the drift and diffusion matrix. We perform a numerical analysis of the model by investigating a cross section of the term structures comparing the results with those obtained with an uncoupled bivariate CIR model.

Keywords: Interest rates, Multidimensional CIR processes, Potential theory

JEL Classification: E43

Suggested Citation

Bertini, Lorenzo and Passalacqua, Luca, Modelling Interest Rates by Correlated Multi-Factor CIR-Like Processes (July 24, 2008). Available at SSRN: https://ssrn.com/abstract=1175702 or http://dx.doi.org/10.2139/ssrn.1175702

Lorenzo Bertini

Sapienza University of Rome ( email )

Piazzale Aldo Moro 5
Piazzale Aldo Moro, 5
Roma, Rome 00185
Italy

Luca Passalacqua (Contact Author)

La Sapienza, University of Rome ( email )

Viale Regina Elena, 295
Rome, 00161
Italy

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
209
Abstract Views
965
Rank
264,034
PlumX Metrics