In
finance
Finance refers to monetary resources and to the study and Academic discipline, discipline of money, currency, assets and Liability (financial accounting), liabilities. As a subject of study, is a field of Business administration, Business Admin ...
, the Chen model is a
mathematical model
A mathematical model is an abstract and concrete, abstract description of a concrete system using mathematics, mathematical concepts and language of mathematics, language. The process of developing a mathematical model is termed ''mathematical m ...
describing the evolution of
interest rate
An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, ...
s. It is a type of "three-factor model" (
short-rate model
A short-rate model, in the context of interest rate derivatives, is a mathematical model that describes the future evolution of interest rates by describing the future evolution of the short rate, usually written r_t \,.
The short rate
Under a sh ...
) as it describes interest rate movements as driven by three sources of market risk. It was the first
stochastic Stochastic (; ) is the property of being well-described by a random probability distribution. ''Stochasticity'' and ''randomness'' are technically distinct concepts: the former refers to a modeling approach, while the latter describes phenomena; i ...
mean and
stochastic volatility
In statistics, stochastic volatility models are those in which the variance of a stochastic process is itself randomly distributed. They are used in the field of mathematical finance to evaluate derivative securities, such as options. The name ...
model and it was published in 1994 by
Lin Chen, economist, theoretical physicist and former lecturer/professor at Beijing Institute of Technology, American University of Beirut, Yonsei University of Korea, and SunYetSan University .
The dynamics of the instantaneous interest rate are specified by the
stochastic differential equations
A stochastic differential equation (SDE) is a differential equation in which one or more of the terms is a stochastic process, resulting in a solution which is also a stochastic process. SDEs have many applications throughout pure mathematics and ...
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In an authoritative review of modern finance (''Continuous-Time Methods in Finance: A Review and an Assessment''
), the Chen model is listed along with the models of
Robert C. Merton
Robert Cox Merton (born July 31, 1944) is an American economist, Nobel Memorial Prize in Economic Sciences laureate, and professor at the MIT Sloan School of Management, known for his pioneering contributions to continuous-time finance, especia ...
,
Oldrich Vasicek, John C. Cox, Stephen A. Ross,
Darrell Duffie,
John Hull, Robert A. Jarrow, and
Emanuel Derman
Emanuel Derman (born 1945) is a South African-born academic, businessman and writer. He is best known as a quantitative analyst, and author of the book ''My Life as a Quant: Reflections on Physics and Finance''.
He is a co-author of BlackāD ...
as a major term structure model.
Different variants of Chen model are still being used in financial institutions worldwide. James and Webber devote a section to discuss Chen model in their book; Gibson et al. devote a section to cover Chen model in their review article. Andersen et al. devote a paper to study and extend Chen model. Gallant et al. devote a paper to test Chen model and other models; Wibowo and Cai, among some others, devote their PhD dissertations to testing Chen model and other competing interest rate models.
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{{DEFAULTSORT:Chen Model
Interest rates
Fixed income analysis
Short-rate models
Financial models