Interest Rate Term Structure Modelling*

In Part II Chap. 17 , we have presented the pricing for vanilla interest rate products that do not require the modelling of interest rate term structure. However, structures with features such as path-dependency or callability usually require the modelling of term structure for pricing and risk management. In this chapter, we first present the concepts and the relationships between zero coupon bond, short rate and forward rate that are essential for interest rate term structure modelling. Then we introduce the Heath–Jarrow–Morton framework with the no-arbitrage condition, which will give birth to different short rate models. Lastly, we study the BGM model that deals with the forward rates directly.