A Nonlinear Non-probabilistic Spot Interest Rate Model

David Epstein, Paul Wilmott

Abstract

We show how to use 'uncertainty' in place of the more traditional Brownian 'randomness' to model a short-term interest rate. The advantage of this model is principally that it is difficult to show statistically that it is wrong. Whether the model is useful for pricing fixed-income products is less clear. We discuss the pros and cons of the model, showing how to price and hedge various contracts, saying which are easy and which are hard.

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