ABSTRACT
SHORT-RATE MODELS HOLD a special place in fixed-income modeling:they are the first generation of interest-rate models, and some of them still play active roles in today’s applications. Short-rate models remain attractive due to two distinguishing advantages. First, they are intuitive, as many of them were established based on theories from financial economics. Second, as Markovian models of single-state variables, they can be implemented by lattice trees, so they are often used for pricing path-dependent options. One of the two objectives of this chapter is to study the implementation of short-rate models by lattice methods. The other objective is, in continuing the theoretical analysis of the HJM framework in Chapter 4, to study under what conditions an HJM model implies a Markovian short-rate model.
