Vasicek Interest Rate Model

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

BREAKING DOWN '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. Hull–White Model

    A single-factor interest model used to price derivatives. The ...
  2. Stochastic Modeling

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

    An interest rate on a liability, such as a loan or mortgage, ...
  4. Heath-Jarrow-Morton Model - HJM ...

    A model that applies forward rates to an existing term structure ...
  5. Rate Level Risk

    A type of interest rate risk which asserts that the characteristics ...
  6. Interest Rate Gap

    The difference between fixed rate liabilities and fixed rate ...
Related Articles
  1. Options & Futures

    How Interest Rates Affect The U.S. Markets

    Interest rates can have both positive and negative effects on U.S. stocks, bonds and inflation.
  2. Credit & Loans

    All Your Questions About Loan Interest Rates

    If you think interest rates don’t really matter -- think again. Interest rates have a huge impact on your finances.
  3. Economics

    10 Countries With Lower Interest Rates Than the US

    Learn about the 10 countries with lower interest rates than the United States and how interest rates indicate a country's economic outlook.
  4. Investing Basics

    Managing Interest Rate Risk

    Interest rate risk stems from the possibility that an interest-bearing asset’s value will change due to changing interest rates.
  5. Options & Futures

    How & Why Interest Rates Affect Options

    The Fed is expected to change interest rates soon. We explain how a change in interest rates impacts option valuations.
  6. Investing News

    Implications of the Federal Reserve's Impending Rate Hike

    The Federal Reserve begins its two-day meeting on Wednesday, September 16, and everyone is watching to see if the central bank will raise the United States target interest rate for the first ...
  7. Economics

    When Will Interest Rates Rise?

    Find out if -- and why -- the Federal Reserve will keep raising interest rates and what that might mean for savers, investors and the entire economy.
  8. Professionals

    DCF Vs. Comparables: Which One To Use

    DCF and Comparables models are widely used in equity valuation. We explain the pros and cons of each method.
  9. Economics

    What is a Business Model?

    Business model is the term for a company’s plan as to how it will earn revenue.
  10. Options & Futures

    Managing Interest Rate Risk

    Learn which tools you need to manage the risk that comes with changing rates.
RELATED FAQS
  1. What is the difference between real and nominal interest rates?

    Learn what nominal interest rates and real interest rates are, how real interest rate takes into account the inflation rate, ... Read Answer >>
  2. What does a climbing interest rate risk signify about the economy?

    Learn what a climbing interest rate risk signifies for the economy. Interest rate risk is heightened with inflationary pressures ... Read Answer >>
  3. How do interest rates impact risk aversion in the market?

    Learn why interest rates and risk aversion have an endogenous relationship in the market, and why interest rates play such ... Read Answer >>
  4. What is affected by the interest rate risk?

    Find out more about interest rate risk, how bond prices are affected by interest rate fluctuations and how interest rate ... Read Answer >>
  5. What are the advantages of using an effective interest rate figure?

    Understand what is meant by the effective interest rate, and learn why the effective rate calculation is preferred over the ... Read Answer >>
  6. What happens if interest rates increase too quickly?

    Learn about what happens if interest rates rise too fast and understand what goes into the Fed’s decision to adjust interest ... Read Answer >>
Hot Definitions
  1. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  2. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  3. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  4. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  5. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  6. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
Trading Center