Table of Contents
ISRN Probability and Statistics
Volume 2012 (2012), Article ID 673607, 16 pages
http://dx.doi.org/10.5402/2012/673607
Research Article

A General Gaussian Interest Rate Model Consistent with the Current Term Structure

Unipol Assicurazioni, via Stalingrado 45, Bologna, Italy

Received 25 April 2012; Accepted 29 July 2012

Academic Editors: J. Abellan and P. E. Jorgensen

Copyright © 2012 Marco Di Francesco. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

Abstract

We describe an extension of Gaussian interest rate models studied in literature. In our model, the instantaneous spot rate ๐‘Ÿ is the sum of several correlated stochastic processes plus a deterministic function. We assume that each of these processes has a Gaussian distribution with time-dependent volatility. The deterministic function is given by an exact fitting to observed term structure. We test the model through various numeric experiments about the goodness of fit to European swaptions prices quoted in the market. We also show some critical issues on calibration of the model to the market data after the credit crisis of 2007.