Chen model

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The first stochastic mean and stochastic volatility model was described by Lin Chen in 1996. The model and its different versions are still popular in the market today. The model is a short-rate model. In general, it has dynamicsdr_t = (\theta_t-\alpha_t)\,dt + \sqrt{r_t}\,\sigma_t\, dW_t, d \alpha_t = (\zeta_t-\alpha_t)\,dt + \sqrt{\alpha_t}\,\sigma_t\, dW_t, d \sigma_t = (\beta_t-\sigma_t)\,dt + \sqrt{\sigma_t}\,\eta_t\, dW_t.



[edit] References

  • Lin Chen (1996). Interest Rate Dynamics, Derivatives Pricing, and Risk Management. Springer. 
  • Lin Chen (1996). Stochastic Mean and Stochastic Volatility -- A Three-Factor Model of the Term Structure of Interest Rates and Its Application to the Pricing of Interest Rate Derivatives. Blackwell Publishers. 
  • Jessica James and Nick Webber (2000). Interest Rate Modelling. Wiely Finance. 
  • Rajna Gibson,François-Serge Lhabitant and Denis Talay (2001). Modeling the Term Structure of Interest Rates: A Review of the Literature. RiskLab, ETH. 
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