Finance - Fixed Income Securities Essay Example | Topics and Well Written Essays - 1500 words

Finance - Fixed Income Securities - Essay Example The market participants usually consider the risk free investments such as government treasuries as well as other securities as bench mark to measure and compare the term structure of the different fixed income securities. Depending upon the nature of the relationship, different shapes of the term structure can be obtained in order to analyze how the interest rates are behaving against their maturities and how the market may respond to the future changes. Though above description may seem easy to follow however, determining the term structure exactly or with relative accuracy is really difficult. Different models have been developed to understand the term structure in better way and as such efforts by Vasicek and Cox- Ingersoll-Ross seem to be two of the most important theoretical advances ever made in this direction. This paper is divided into two parts, in first part, a detailed description of the Term Structure models of Vasicek and Cox- Ingersoll-Ross will be discussed along with their benefits whereas in second part of this essay, an analysis will be provided as to whether both the models can empirically be supported or not and which model is more suitable for empirical testing. Vasicke’s model is one of the earliest term structure models and is probably the first serious effort towards studying the term structure models from an academic point of view. Vasicke’s model is based on two basic assumptions while dealing with the term structure of the interest rates. First, it assumes that the whole term structure depends upon the given interest rates for a very short period of time. This interest rate is considered as the spot rate and as such the spot rates are considered as mean reversing in nature.(Beninniga & Czaczkes,2000). One of the most important characteristics of the Vasicke’s model is the fact that it is a one factor model and is a