Template-Type:ReDIF-Paper 1.0  
Title:On Short Rate Processes and Their Implications for Term Structure Movements
Author-Name: Schl&oumlgl, Erik 
Author-Name: Daniel Sommer
Classification-JEL:G13 
Keywords:arbitrage, term structure of interest rates, spread option pricing 
Abstract:We compare short rate diffusion models with respect to their implications for term structure movements, the
	plausiblity of which serves us as a criterion for evaluating the models. Analytically for Gauss-Markov models and
	numerically for a broader collection of models prevalent in the literature, we isolate the deformations of the term structure
	generated endogenously. Among other analytical tools we use spread options on the forward rate curve as an aggregate
	measure of term structure shapes across states. On the basis of our analysis we conclude that the Ho/Lee model should be
	discarded, since it cannot explain the emergence of downward sloping term structures, that the introduction of mean
	reversion is essential in order to generate downward sloping term structures in any substantial proportion, that the models
	typically favor upward sloping term structures for short maturities and downward sloping term structures for longer
	maturities, and that there is a surprisingly strong similarity among many of the models prevalent in the literature. A model
	which allows arbitrary boundaries for the short rate realizations to be fixed exogenously completes our analysis. 
Length: pages
Creation-Date: 1994-10
Revision-Date: 
Handle: RePEc:bon:bonsfb:293
File-URL: http://www.wiwi.uni-bonn.de/bgsepapers/bonsfb/bonsfb293.pdf
File-Format: application/pdf
File-Size: 513467 bytes