Cox Ingersoll Ross Model – Solved Example
LOS: Calculate the short-term rate change and describe the basis point volatility using the CIR and lognormal models.
Question:
The short rate is currently observed to be 4.00% and it’s annualized standard deviation has been estimated to be 80 bps. Tabulated below are two parameters for the Cox Ingersoll Ross (CIR) model:
Parameter | Value |
Strength of Reversion ($k$) | 0.70 |
Long-run Interest Rate ($\theta$) | 7.00% |
Using the above information, estimate the following:
- The $\sigma$ parameter for this CIR model,
- The “basis point volatility” if the short rate increases to 6.00%.
A. | 0.008 and 98 bps |
B. | 0.04 and 98 bps |
C. | 0.04 and 80 bps |
D. | 0.008 and 80 bps |