Focus Interest-Rate Models
Fraunhofer ITWM
Interest rates are not constant with respect to time. Each consumer is subject to this experience regarding the credit as well as the debit side.
Although interest rates usually do not fluctuate as strongly as equity prices, the future development of interest rates can only be predicted with difficulty, because it is subject to different economic and macro-economic influences.
Especially market interest rates, such as the EURIBOR interest rates (the interest rates at which the banks on the Euro market borrow money from one another) with their different terms, react to changing market conditions, so that stochastic modeling appears appropriate. Because of the large volumes of transactions carried out on the interest rate market, it is very important that the development of interest rates is modeled as realistically as possible.
In contrast to the modeling of equity prices, however, no benchmark model, such as the Black-Scholes model for equity prices, has yet been developed for interest rates. There are numerous interest rate models which must be examined with respect to a possible application and selected, depending on the product and the basic interest rate.
A further special feature of the interest rate market is the very large variety of complex interest rate derivatives. Their contract structure is often difficult to understand, so that pricing is a strong challenge to financial mathematics.
Markets are currently focused on, e. g. inflation-bound bonds and derivatives, whose payments hedge the investor against changes of purchasing power because they are coupled to inflation development. The modeling of inflation and the pricing of the above mentioned products belong to the current research and project work of the Fraunhofer ITWM.
