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. 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

Hot Definitions
  1. Hyperinflation

    Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Hyperinflation is ...
  2. Gross Rate Of Return

    The total rate of return on an investment before the deduction of any fees or expenses. The gross rate of return is quoted ...
  3. Debit Spread

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

    A measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators ...
  5. Wage-Price Spiral

    A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. ...
  6. Accelerated Depreciation

    Any method of depreciation used for accounting or income tax purposes that allows greater deductions in the earlier years ...
Trading Center