Furthermore, our study extends Amin and Morton (1994) and Klassen, Dressien and Pelsser (1999) by considering that the volatility structure depends on the level of the spot interest rate.
In this case the volatility structure becomes deterministic and the spot interest rate becomes the only state variable.
Pelsser, 2000, "Forward versus Spot Interest Rate Models of the Term Structure: An Empirical Comparison", The Journal of Derivatives 7, 9-21.
Having analyzed the length of the relationship between lagged forward rates and the spot interest rate, we can explore the direction of the influence on the relationship between the Treasury and swap yield curves.
For this segment of the curve, the hedging of options exposures to the three-to-five-year forward rate and the five-to-ten-year forward rate could have an effect on the five-year spot interest rate.
The interest rate with the shortest maturity is commonly called the spot interest rate, r.
When the spot interest rate r is above or below the long-term spot interest rate, [r.
The model assumes that the only uncertainty affecting the value of the project is the term structure movement due to the evolution of the spot interest rate.
The term structure of interest rates or zero-coupon yield curve characterizes relation between spot interest rates
in the economy and the term to maturity of default-free fixed income securities in the market.