Jarrow Turnbull Model

The Jarrow-Turnbull model is a term structure model that is used to price interest rate derivatives. It was developed by Robert Jarrow and Stuart Turnbull in 1995.

The Jarrow-Turnbull model is a two-factor model, which means that it uses two factors to model the term structure of interest rates. The two factors are the short-term interest rate and the long-term interest rate.

The short-term interest rate is the interest rate that is used to discount cash flows that are due in the near future. The long-term interest rate is the interest rate that is used to discount cash flows that are due in the distant future.

The Jarrow-Turnbull model assumes that the short-term interest rate is a random walk. This means that the short-term interest rate can change in any direction at any time. The Jarrow-Turnbull model also assumes that the long-term interest rate is a function of the short-term interest rate.

The Jarrow-Turnbull model can be used to price a variety of interest rate derivatives, such as interest rate swaps, caps, floors, and collars.

The Jarrow-Turnbull model is a relatively simple model, but it is still able to provide accurate pricing for interest rate derivatives. However, the Jarrow-Turnbull model does not take into account the effects of volatility and liquidity on the term structure of interest rates.

Despite its limitations, the Jarrow-Turnbull model is a useful tool for pricing interest rate derivatives.