interest rate trees. only, interest, question, studying

sabaruch

first for those of you simply worried about passing the exam, dont bother with this and keep studying...

question:

when constucting interest rate trees, you can use diff models as the CFAI book sais...

i am not seeing how that would work, if you assume your UP is 7, there is only one value that work work for your DOWN....

now it appears to me that the model diff must be about how volitilty is interpruted, but should not that be agreed upon...thus one model, the one in the book, which actually makes "mathmatical sense"

the one in book basicly assume this, take the mid of up and down, devide by 2
now if you multiply by 1+v you get high, if you devide by 1+v you get low

so makes mathmatical sense...

if someone can maybe show another model they know off, or anything, that would be great

FinancialAnaly

corection, take the sum of up and down, devide by 2*

YAhmed

why is this relevant

giants2010

You can solve for any kind of up or down step, provided that your tree converges in subsequent nodes. Each node doesn't even need to use the same steps, time period, etc. You can even use three or more branches per node. If you're interested in this topic, you should probably pick up a stochastic process book. The CFA text talks about this only superficially.