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

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

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

    A security whose price is dependent upon or derived from one ...
  5. Standard Deviation

    1. A measure of the dispersion of a set of data from its mean. ...
  6. Interest Rate Risk

    The risk that an investment's value will change due to a change ...
Related Articles
  1. Investing

    Who determines interest rates?

    In countries using a centralized banking model, interest rates are determined by the central bank. In the first step of interest rate determination, the government's economic observers create ...
  2. Markets

    The Uses And Limits Of Volatility

    Check out how the assumptions of theoretical risk models compare to actual market performance.
  3. 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.
  4. Economics

    Forces Behind Interest Rates

    Get a deeper understanding of the importance of interest rates and what makes them change.
  5. 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.
  6. 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.
  7. Investing Basics

    What Investors Should Know About Interest Rates

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

    Bet Smarter With The Monte Carlo Simulation

    This technique can reduce uncertainty in estimating future outcomes.
  9. 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.
  10. Options & Futures

    What are the differences between divergence and convergence?

    Find out what technical analysts mean when they talk about a market experiencing divergence or convergence and how they affect trading strategies.

You May Also Like

Hot Definitions
  1. Deferred Revenue

    Advance payments or unearned revenue, recorded on the recipient's balance sheet as a liability, until the services have been ...
  2. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  3. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  4. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  5. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
  6. Annual Percentage Rate - APR

    The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents ...
Trading Center