Evolution of Interest Rate Models: A Comparison

Abstract

Derivatives based on interest-sensitive securities are very widespread and extremely important, but their prices cannot be adequately modeled using the Black-Scholes equation. Numerous approaches have been introduced over the years, culminating in today's arbitrage-free models that are tuned to match the initial term structure exactly. This article reviews the evolution of interest rate models from the initial single-factor relative valuation approaches related to Black-Scholes, up to the present "state of the art."

JEL Classification: C00