The real challenge was to model all the interest rates simultaneously, so you could value something that depended not only on the three-month interest rate, but on other interest rates as well.
More Quotes from John Hull:We started giving presentations at practitioner conferences in 1986, and since then all of our derivatives research has been stimulated by contact with practitioners.
I didn't become interested in derivatives until 1982, 1983.
The problem with interest rates are that you are not modeling a single number, you are modeling a whole term structure, so it is a sort of different type of problem.
Our tree is actually a tree of the short-term interest rate. The average direction in which the short-term interest rate moves depends on the level of the rate. When the rate is very high, that direction is downward; when the rate is very low, it is upward.
Our research led on to other things, such as the fact that exchange rates are not lognormally distributed.
Our starting point then was trying to find a way to incorporate mean reversion into the HoLee model.
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