Ho-Lee Model

The Ho-Lee model is an important concept of financial mathematics. The Ho-Lee Model deals with rates of interest that are supposed to prevail in the future.
It is regarded as a very simple model as it can be adjusted as per information collected from markets. The Ho-Lee model could also be called a term structure model. It was the first of its kind in financial mathematics.

Description of Ho-Lee Model
The
Ho-Lee model
considers the current yield curve to be fixed. It constructs a binomial model that lies close to this current yield curve. To be exact, the price curve or the discount factor curve is very important in this context.

With the
Ho-Lee model
it is assumed that there would be one up term structure and one down term structure from a given term structure that is made up of discount factors. The period considered in this case is that of a year.
Equational Representation of Ho-Lee Model
The equational representation of the Ho-Lee model is as follows:

drt = φtdt + σdWt

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Last Updated on : 1st July 2013