Efficient calibration of trinomial trees for one-factor short rate models

Markus Leippold*, Zvi Wiener

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

3 Scopus citations

Abstract

In this paper we propose a computationally efficient implementation of general one factor short rate models with a trinomial tree. We improve the Hull-White's procedure to calibrate the tree to bond prices by circumventing the forward rate induction and numerical root search algorithms. Our calibration procedure is based on forward measure changes and is as general as the Hull-White procedure, but it offers a more efficient and flexible method of constructing a trinomial term structure model. It can be easily implemented and calibrated to both prices and volatilities.

Original languageAmerican English
Pages (from-to)213-239
Number of pages27
JournalReview of Derivatives Research
Volume7
Issue number3
DOIs
StatePublished - Dec 2004

Bibliographical note

Funding Information:
The authors thank seminar participants at the Z-Quants Workshop of the Zürcher Kan-tonalbank. Furthermore, we would like to thank Menachem Brenner, Paolo Vanini, Ton Vorst, and Simon Benninga for their comments. Markus Leippold acknowledges the financial support of the Swiss National Science Foundation (NCCR FINRISK). Zvi Wiener acknowledges the financial support of the Krueger and Rosenberg funds at the Hebrew University of Jerusalem. We welcome comments, including references to related papers we inadvertently overlooked.

Keywords

  • Forward measure
  • Short rate models
  • Trinomial trees

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