Saturday, June 13, 2015

mean reversion in Hull-White model

The (well-known) mean reversion is in drift, i.e. the inst drift, under physical measure.

(I think historical data shows mean reversion of IR, which is somehow related to the "mean reversion of drift"....)

When changing to RN measure, the drift is discarded, so not relevant to pricing.

However, on a "family snapshot", the implied vol of fwd Libor rate is lower the further out accrual startDate goes. This is observed on the market [1], and this vol won't be affected when changing measure. Hull-White model does model  this feature:


[1] I think this means the observed ED future price vol is lower for a 10Y expiry than a 1M expiry.

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