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. Standard Deviation

    1. A measure of the dispersion of a set of data from its mean. ...
  3. Derivative

    A security whose price is dependent upon or derived from one ...
  4. Interest Rate

    The amount charged, expressed as a percentage of principal, by ...
  5. Interest Rate Risk

    The risk that an investment's value will change due to a change ...
  6. Monte Carlo Simulation

    A problem solving technique used to approximate the probability ...
RELATED FAQS
  1. Who determines interest rates?

    In countries using a centralized banking model, interest rates are determined by the central bank. In the first step of ... Read Full Answer >>
  2. In what manner will a recession likely affect the marginal-propensity-to-save rate ...

    The marginal propensity to save, or MPS, rises in most, though not all, recessions. This makes perfect sense on an individual ... Read Full Answer >>
  3. Why would a country's gross domestic product (GDP) and gross national income (GNI) ...

    A country’s gross domestic product, or GDP, and gross national income, or GNI, are likely to differ considerably because ... Read Full Answer >>
  4. While closely related, how do gross domestic product (GDP) and gross national income ...

    Gross domestic product, or GDP, and gross national income, or GNI, are the two most important economic indicators that measure ... Read Full Answer >>
  5. What are the similarities and differences between the savings and loan (S&L) crisis ...

    The savings and loan crisis and the subprime mortgage crisis both began with banks creating new profit centers following ... Read Full Answer >>
  6. How does the effective interest method treat the interest on a bond?

    The effective interest method is used when evaluating the interest generated by a bond because it considers the impact of ... Read Full Answer >>
Related Articles
  1. Markets

    The Uses And Limits Of Volatility

    Check out how the assumptions of theoretical risk models compare to actual market performance.
  2. Investing

    The Ups And Downs Of Investing In Cyclical Stocks

    This strategy can be profitable but only if you know when to dump these stocks.
  3. Economics

    Forces Behind Interest Rates

    Get a deeper understanding of the importance of interest rates and what makes them change.
  4. Investing Basics

    How Interest Rates Affect The Stock Market

    Whether you're buying lunch, a home or a stock, you're influenced by interest rates.
  5. Personal Finance

    How The U.S. Government Formulates Monetary Policy

    Learn about the tools the Fed uses to influence interest rates and general economic conditions.
  6. Investing Basics

    What Investors Should Know About Interest Rates

    Understanding interest rates helps you answer the fundamental question of where to put your money.
  7. Active Trading Fundamentals

    Bet Smarter With The Monte Carlo Simulation

    This technique can reduce uncertainty in estimating future outcomes.
  8. Bonds & Fixed Income

    Advanced Bond Concepts

    Learn the complex concepts and calculations for trading bonds including bond pricing, yield, term structure of interest rates and duration.
  9. Markets

    Rising Interest Rates: Who it Helps, Who it Hurts

    When interest rates rise, the impact hits some of us differently. Here's why.
  10. Stock Analysis

    3 Stocks To Buy and Hold For the Rest of 2015

    One of the dominant themes to consider for 2015 is the normalization of monetary policy as the Fed raises interest rates.

You May Also Like

Hot Definitions
  1. Treasury Yield

    The return on investment, expressed as a percentage, on the debt obligations of the U.S. government. Treasuries are considered ...
  2. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
  3. European Central Bank - ECB

    The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed ...
  4. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
  5. Current Account Deficit

    A measurement of a country’s trade in which the value of goods and services it imports exceeds the value of goods and services ...
  6. International Monetary Fund - IMF

    An international organization created for the purpose of: 1. Promoting global monetary and exchange stability. 2. Facilitating ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!