I double checked and at least one of the FSA exam questions (q3) I answered involved evaluating interest rate models. At the time (2009) advantages/disadvantages included whether or not the model produced negative yields, and negative rates were considered a disadvantage. Given the rising propensity of negative yields in the Eurozone, I'm curious on whether the pro's con's still hold or at least are still tested the same way...
1. Negative interest rates are still a "disadvantage" in the models because the context is often valuing option prices and other financial instruments and they cause weird results. In other words, whether or not negative yields actually exist is a separate issue from how the interest models actually operate.
2. In a world with negative yields, the economic reality is probably pretty screwy, so "textbook" valuation of financial derivatives is going to have to take a back seat.
1. Negative interest rates are still a "disadvantage" in the models because the context is often valuing option prices and other financial instruments and they cause weird results. In other words, whether or not negative yields actually exist is a separate issue from how the interest models actually operate.
2. In a world with negative yields, the economic reality is probably pretty screwy, so "textbook" valuation of financial derivatives is going to have to take a back seat.
Negative Interest Rates
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