Definition of Hull-White Model
In finance, Hull–White model is described as a model of future interest rates; this is a one-factor interest model with the motive to price the derivatives. In an assumption of Hull–White model, a short rate supposed to have a normal distribution, and the short rate is mean reverting. In this model, volatility is low when the interest rates are counted as near zero, which is represented larger mean of reversion in the model.
- By John C. Hull and Alan White in 1990, Hull–White model is first introduced in finance. This model is gaining its enormous popularity in the market by the time.
- The disadvantage that Hull–White model carries is that, they have too little parameter to closely fit the initial yield curve within given time. In this model, the coefficients are time dependable that enable one has to fit perfectly.
Books on Hull-White Model
Efficient Methods for Valuing Interest Rate Derivatives By Antoon Pelsser (published by Springer Science & Business Media, 2000)
The Mathematics of Derivatives: Tools for Designing Numerical Algorithms By Robert L. Navin (published by John Wiley & Sons, 2007
How Hull-White Model works?
Here are a few practical examples of applications of Hull–White model in real life finance encounters, with the discussed examples anyone can grasp the notion of Hull–White model and its process in finance,
- Investments whose values are counted as per interest rates, as examples bond options and mortgage-backed securities. These investments have made its mark prominent in the financial era as the society has become sophisticated. The value of these investments are usually determined by various models and it is seen that different models have different assumptions like, Hull–White model has
- Like the Ho-Lee model, the Hull-White model interest rates are distributed normally, which is considered as one of the weaknesses of this model. Though the model goes further, the interest rates are counted as negative; this leaves low probability of this occurring as a model output. This model is used to price the derivative as a function of the entire yield curve, and the discount bonds. The instruments like caps and floors can be expressed in term of options on discount bonds.
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