Explain the treatment of the dynamics of the volatility term for the Dothan interest rate model
What will be an ideal response?
For the Dothan interest rate model, we look at the case for ? = 1 . Substituting this value for ? into ?r?dz, we get the following model identified by Dothan who first proposed it:
? = 1: ?(r,t) = ? r (Dothan specification of CEV model).
In the Dothan specification, volatility is proportional to the short rate. This model is referred to as the proportional volatility model.
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