Vasicek Interest Rate Model

AAA

DEFINITION of 'Vasicek Interest Rate Model'

A method of modeling interest rate movement that describes the movement of an interest rate as a factor of market risk, time and equilibrium value that the rate tends to revert towards. This stochastic model is often used in the valuation of interest rate futures.

The Vasicek interest rate model values the instantaneous interest rate using the following equation:

drt = a(b-rt)dt +sdWt

Where Wt is the random market risk (represented by the Wiener process)
t represents time
a(b-rt) represents the expected change in the interest rate at t (drift factor)
a is the speed of reversion
b is the long-term level of the mean
s is the volatility at the time

INVESTOPEDIA EXPLAINS 'Vasicek Interest Rate Model'

The Vasicek interest rate model states that the movement of interest rates is affected only by random market movements. In the absence of market shocks (i.e., when dWt = 0) the interest rate remains constant (rt = b). When rt < b, the drift factor becomes positive, indicating that the interest rate will increase towards equilibrium.

RELATED TERMS
  1. Cox-Ingersoll-Ross Model - CIR ...

    A mathematical formula used to model interest rate movements ...
  2. Interest Rate Differential - IRD

    A differential measuring the gap in interest rates between two ...
  3. Stochastic Modeling

    A method of financial modeling in which one or more variables ...
  4. Interest Rate

    The amount charged, expressed as a percentage of principal, by ...
  5. Monte Carlo Simulation

    A problem solving technique used to approximate the probability ...
  6. Derivative

    A security whose price is dependent upon or derived from one ...
Related Articles
  1. Who determines interest rates?
    Investing

    Who determines interest rates?

  2. The Uses And Limits Of Volatility
    Markets

    The Uses And Limits Of Volatility

  3. The Ups And Downs Of Investing In Cyclical ...
    Investing

    The Ups And Downs Of Investing In Cyclical ...

  4. Forces Behind Interest Rates
    Economics

    Forces Behind Interest Rates

comments powered by Disqus
Hot Definitions
  1. Market Segmentation

    A marketing term referring to the aggregating of prospective buyers into groups (segments) that have common needs and will ...
  2. Effective Annual Interest Rate

    An investment's annual rate of interest when compounding occurs more often than once a year. Calculated as the following: ...
  3. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...
  4. Odious Debt

    Money borrowed by one country from another country and then misappropriated by national rulers. A nation's debt becomes odious ...
  5. Takeover

    A corporate action where an acquiring company makes a bid for an acquiree. If the target company is publicly traded, the ...
  6. Harvest Strategy

    A strategy in which investment in a particular line of business is reduced or eliminated because the revenue brought in by ...
Trading Center