Understanding Interest Rate Models and Term Structure Dynamics

Very Hard Term Structure Dynamics Interest Rate Models

Consider a financial analyst evaluating the implications of various interest rate models on the dynamics of the term structure of interest rates. The analyst is particularly interested in the pricing of zero-coupon bonds over different maturities under the Vasicek, Cox-Ingersoll-Ross (CIR), and Hull-White models. Each model stipulates different market behavior regarding how interest rates evolve over time.

Based on your knowledge of these models, which of the following statements presents an accurate understanding of how they treat interest rate movements and their implications for the term structure?

The Vasicek model assumes interest rates follow a geometric Brownian motion, leading to non-stationary term structures.

The CIR model predicts interest rates will not become negative, as it incorporates square root diffusion.

The Hull-White model is based on a constant instantaneous volatility, resulting in a flat term structure.

Hint

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