Vasicek Interest Rate Model - Explained
What is the Vasicek Interest Rate Model?
Written by J. Mance Gordon
Updated at April 23rd, 2024
- Marketing, Advertising, Sales & PR
- Accounting, Taxation, and Reporting
- Professionalism & Career Development
-
Law, Transactions, & Risk Management
Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
- Business Management & Operations
- Economics, Finance, & Analytics
What is the Vasicek Interest Rate Model?
The Vasicek interest rate model is a model that exhibits fluctuations or movements in interest rate. This mathematical model tells how factors such as market risk, time, and equilibrium price affect the interest rate movements. Here, the interest rate responds towards the average of the factors over a period of time. Most importantly, it ascertains the point that will mark the end of interest rates at the end of a specific time period, provided a specific market risk factor, volatility in the current market, and the average interest rate value in the long term. However, one must know that this equation has the ability to evaluate only one market risk factor at one point of time. This model is considered for knowing the value of interest rate futures, as well as for identifying the prices of several bonds that are not easy to value.
How does the Vasicek Interest Rate Model Work?
The Vasicek interest rate model ascertains the value of interest rate by considering the following equation: drt = a (b rt) dt + dWt where: W stands for random market risk (displayed by a Wiener process) t stands for time period a (brt) stands for the Expected change in the interest rate at time t (the drift factor) a stands for the speed of the reversion to the mean B stands for the long-term level of the mean stands for volatility at time t d stands for variable derivative that follows it
How is The Vasicek Interest Rate Model Used?
The concept of Vasicek interest rate model is applied to financial economics so as to make predictions for prospective pathways in case of interest rate fluctuates ahead. This model is based on the belief that the random market fluctuations have a significant effect on the interest rate movements. In case, the market fluctuations are zero, or when dWt is equal to 0, there is no movement in the interest rate, that means rt = b. When rt is less than b, the drift factor turns out to be positive. This positive value signifies that the rate of interest will go up in the direction of equilibrium. Though this model is impressive when it comes to predicting financial equations, but it is recently known that the interest rate under this model doesnt go beyond zero, or doesnt turn out to be negative. This drawback was ascertained during the huge financial crisis. Several models such as the Cox-Ingersoll-Ross model and the exponential Vasicek model which were formulated after the Vasicek model, overcame this issue for predicting the movements in interest rates.
Related Topics
- Legal Tender
- Numismatics
- Gresham's Law
- Barter
- Double Coincidence of Wants
- Parity
- Functions of Money
- Medium of Exchange
- Unit of Account
- Store of Value
- Time Value of Money
- Standard of Deferred Payment
- Liquidity Preference Theory
- National Savings and Investment Identity
- Circular Flow of Money
- Commodity Money
- Gold Exchange Standard
- Bretton Woods System
- Fiat Money
- Money Supply
- M1 and M2 Money Supply
- Monetary Base
- Savings, Demand, and Time Deposits
- Banks
- How Do Banks Create Money?
- Financial Intermediary
- Bank Balance Sheet
- Money Multiplier Formula
- Velocity of Money
- Multiplier Effect
- Quantity Equation of Money
- McCallum Rule
- Neutrality of Money
- Real Bills Theory
- Banking System?
- Central Bank
- Federal Reserve System
- Federal Open Market Committee (FOMC)
- Fed Balance Sheet
- Term Auction Facility
- Taylor Rule
- How is the Federal Reserve Bank Organized?
- What is Bank Regulation?
- CAMELS Rating
- FDIC
- CFPB
- Bank Supervision
- Bank Runs
- What is Deposit Insurance?
- Federal Deposit Insurance Corporation
- Lender of Last Resort
- Central Banks Carry Out Monetary Policy
- Open Market Operations
- Bank Reserve
- Discount Rate
- Federal Funds Rate
- Monetary Policy
- Contractionary and Expansionary Monetary Policy
- Loose vs Tight Monetary Policy
- Easy Monetary Policy
- Accommodative Monetary Policy
- Dove & Hawk (Monetary Policy) - Explained
- Tight Monetary Policy - Explained
- Stabilization Policy
- Pushing on a String
- The Effect of Monetary Policy on Interest Rates
- Federal Funds Rate
- Gibson Paradox
- Vasicek Interest Rate Model
- Equation of Exchange (Economics)
- The Effect of Monetary Policy on Aggregate Demand
- Quantitative Easing
- Reserve Currency
- What are Excess Reserves?
- Unpredictable Movements of Velocity
- Central Banks - Unemployment and Inflation
- Inflation Targeting
- Fisher Effect
- Asset Bubbles and Leverage Cycles
- Countercyclical
- Money Capital Market
- Quantity Theory of Money
- Aggregate Expenditure Model
- IS-LM Model
- European Capital Market Institute