IAI Actuarial Core Principles · Economic Modelling · Models of the term structure of interest rates
Which feature distinguishes the Ho-Lee model dr = θ(t)dt + σ dW from the Vasicek model?
Ho-Lee has no mean reversion and uses a time-dependent drift θ(t) calibrated to reproduce the current yield curve exactly. Vasicek has mean reversion with constant parameters, and Ho-Lee rates, being normal, can still go negative.
- AHo-Lee has mean reversion but Vasicek does not
- BHo-Lee has no mean reversion and a time-dependent drift that can fit the initial yield curveCorrect
- CHo-Lee keeps rates strictly positive
- DHo-Lee has volatility proportional to the square root of r
- Ho-Lee has stochastic volatility
Explanation
Ho-Lee has a deterministic, time-dependent drift θ(t) chosen to match the observed initial term structure, but no mean-reversion term. Its rates are normal, so they can be negative.
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