An Extension of the Double Vasicek Model to Account for Stochastic Risk Premia
18 Pages Posted: 1 Nov 2014
Date Written: October 30, 2014
We present a stochastic-market-risk extension of a popular doubly-mean-reverting Vasicek model. The model straddles the P and Q measures. By allowing for a stochastic market price of risk, we break the determninisitc link between the return-predicting factor and the market-price of risk, but we retain, on average, the observed regularities reported in the literature. We also show how the model can be calibrated.
Keywords: affine models, market price of risk, return predicting factor
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