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Explain why interest rate under CIR will not hit zero

C

Chang Liu

Member
hi , i still don't quite understand clearly why interest rate under CIR model will not hit zero by reading the material.
Could you please explain that in more details? Many thanks!
 
The CIR SDE has two parts to it:
- the drift part, which incorporates mean reversion to a long-run mean of mu
- the volatility part, which includes the square root of r(t).

When the interest rate r(t) becomes very small (close to 0), the volatility term also becomes very small, so the SDE defining the process will be dominated by the mean-reverting drift term which drags the process towards the mean and away from 0.
 
Mark Mitchell said:
The CIR SDE has two parts to it:
- the drift part, which incorporates mean reversion to a long-run mean of mu
- the volatility part, which includes the square root of r(t).

When the interest rate r(t) becomes very small (close to 0), the volatility term also becomes very small, so the SDE defining the process will be dominated by the mean-reverting drift term which drags the process towards the mean and away from 0.
Click to expand...
Thanks a lot Mark, I understand it now.
 
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