Hull-white model, Finance Basics

Hull-White model

As an extension of the Vasicek model, Hull-White model (1990) assumed that the short interest rate process follows the mean-reverting stochastic differential equation SDE:

drt = k(Θt - rt)dt +σdWt2,

where k and σ are positive constants,  Θt  is time-dependent function which will be used to currently fit the term structure of interest rate in the market.

while the interest rates are considerable to be stochastic, the tradeable asset evolves according to a geometric Brownian motion. So under the risk-natural measure Q, the dynamic of the instantaneous asset price is given by

dSt =rStdt + σSt dWt1,

where the two increments Wt1 and Wt2are independent Brownian motion process with

dWt1 dWt2 = ρ dt

 ρ representing the instantaneous correlation parameter between the asset price and the short interest rate.

Applying Ito lemma to (ekt) to find the differential of a time-dependent function of a stochastic interest rate process

D(r ekt) = ekt dr + k r ekt dt = kΘtekt dt + σekt dWt2

Then integrate both sides over [s,t] and simplify the equation,

1. Complete what I did before to prove  it is Gaussian and then  is following the normal distribution in clear and specific points?

Posted Date: 2/18/2013 1:20:43 AM | Location : United States







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