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Primary Article

Efficient Trees for CIR and CEV Short Rate Models

Sanjay K. Nawalkha and Natalia A. Beliaeva
The Journal of Alternative Investments Summer 2007, 10 (1) 71-90; DOI: https://doi.org/10.3905/jai.2007.688995
Sanjay K. Nawalkha
An associate professor of finance at Isenberg School of Management, University of Massachusetts in Amherst, MA.
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  • For correspondence: nawalkha@som.umass.edu
Natalia A. Beliaeva
An assistant professor of finance at Suffolk University in Boston, MA.
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  • For correspondence: nbeliaev@suffolk.edu
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Abstract

This article presents truncated-tree transforms for generating binomial and trinomial trees under the Cox, Ingersoll, and Ross (CIR) and constant-elasticity-of-variance (CEV) models of the short rate. The authors correct an error in the original square root transform of Nelson and Ramaswamy [1990], and modify their transform by truncating the tree exactly at the zero-boundary. This not only allows for the creation of more efficient trees for the CIR square-root process, but also for the entire class of CEV models of the short rate. The simulations in this article show fast convergence and significantly improved performance of the truncated-tree approach over the Nelson-Ramaswamy approach.

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The Journal of Alternative Investments
Vol. 10, Issue 1
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Efficient Trees for CIR and CEV Short Rate Models
Sanjay K. Nawalkha, Natalia A. Beliaeva
The Journal of Alternative Investments Jun 2007, 10 (1) 71-90; DOI: 10.3905/jai.2007.688995

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Efficient Trees for CIR and CEV Short Rate Models
Sanjay K. Nawalkha, Natalia A. Beliaeva
The Journal of Alternative Investments Jun 2007, 10 (1) 71-90; DOI: 10.3905/jai.2007.688995
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