Numerical integration of mean reverting stochastic systems with applications to interest rate term structure simulation

Abstract

A proof of convergence is presented for a simplified numerical integration method for solving systems of correlated stochastic differential equations describing mean reverting geometric Brownian motion. Such systems arise in modelling the time evolution of interest rate term structures. For time discretization of size Δt, the method leads to global error in time of O (Δt 2) and no error accumulation. The result is shown to extend to the case when principal components analysis is...