CIR Model

[[email protected]]

Hi All

Is there any quick example to understand this method The Cox Ingersoll Ross Model a one factor model of interest rates.? and any example question to test the concept



Many Thanks

 

[ShaktiRathore]

calculating term structure of interest rates,
suppose that we want to predict interest rate term structure for the coming 12 months. Let initial interest rate be 1% and assume the annual volatility of interest rate be sigma=2.5%, long run rate be theta= 8% which is mean reverting level of interest rate that is interest rate reverts to long run mean level, strength of reversion that is how fast the interest rate drifts back to mean reverting value on average which is k=.6, and time step is monthly can be daily also dt=1/12
For the first month, the random uniform value is 0.71 such that the random standard normal is 0.5534 and dw = 0.5534*SQRT(1/12) = 0.160.
dr = k*(theta - r)*dt + sigma*sqrt(r)*dw = 0.60*(8.0% - 1.0%)*1/12 + 2.5%*SQRT(1.0%)*0.160 = + 0.350% due to mean-reverting drift + 0.040% due to random shock = +0.3900% which is the change in interest rate from previous month as predicted by the model.
such that r(1/12) = 1.0% + 0.390% =1.390% which is the interest rate predicted as per the model in this way continue in this way to end up with the term structure of interest rate for coming 12 months.

thanks

 

[[email protected]]

Thanks Bro!

 

[[email protected]]

dr = k(theta - rate)dt + sigma rt gamma dz

Is gamma missing in your post or i am missing some thing?

 

[David Harper CFA FRM]

We do have a a question (set) on CIR. For paid members only (this is already in the associated PDF): http://forum.bionicturtle.com/threads/p2-t5-307-cox-ingersoll-ross-cir-interest-rate-process.6731/

 

[robe]

I'm hoping someone can help me with a conceptual question about CIR model: dr = k(theta - r)dt + sigma*sqrt(r)*dw

This seems inconsistent since as r -->0, volatility will be decreasing since you will only have one-sided volatility as you approach 0.. this makes sense, however....

When looking at the good old convexity charts plotting price against yield (rate), this seems to imply exactly the opposite... that only a slight change in price will deliver greater variations in the yield (rate), and thus (I) would infer greater interest rate volatility. Can someone help?
Thanks!

 

[southeuro]

I understand the construction of this but am clueless as to where the .04% "random shock" comes from... can anyone explain? much appreciated. thanks

 

[ShaktiRathore]

Randdom shock component is: sigma*sqrt(r)*dw = + 2.5%*SQRT(1.0%)*0.160 = + 0.040% the other one is drift component.
Thanks

 

[southeuro]

thanks shakti!