13.6 Calibration

Hull and White have shown how trinomial trees (lattice) can be used to value interest rate derivatives. The goal of the trinomial lattice is to compute the market price of risk for all buckets for the Ho and Lee or Extended Vasicek (no-arbitrage) term structure models.

Hull and White's lattice is a popular methodology to calibrate a term structure model. The lattice is constructed for up to 360 monthly buckets, from bucket zero to either (the last maturity on the IRC + 15 years) or 30 years, whichever is shorter.