hard · Frm Part 2 Market Risk
A risk analyst is comparing the Vasicek and Cox-Ingersoll-Ross (CIR) term structure models.
If the objective is to ensure that nominal interest rates cannot become negative, which model is appropriate and what is the underlying mathematical constraint?
- CIR; the Feller condition ensures that the mean-reversion level θ is always positive.
- Vasicek; the mean-reversion speed k is calibrated to be higher than the volatility σ.
- CIR; volatility scales with √(r_t), causing volatility to vanish as rates approach zero.
- Vasicek; it is an equilibrium model that assumes rates must stay positive to maintain economic stability.
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