Chen Model is a mathematical model. The Chen Model deals with the interest rates and their development. The Chen Model is important in the context of finance. It was the first stochastic mean and stochastic volatility model and it was published in 1994 by Lin Chen.
The Chen Model could be described as being a certain kind of “one-factor model”. It could also be called a short rate model. There is a reason behind this. As per the Chen Model the interest rates go up or down because of market risk. The Chen Model tries to identify the relationship of market risk with the interest rate trends.
Different variants of Chen model are still being used in financial institutions worldwide. James and Webber devote a section to discuss Chen model in their book; Gibson et al. devote a section to cover Chen model in their review article. Andersen et al. devote a paper to study and extend Chen model. Gallant et al. devote a paper to test Chen model and other models; Cai devotes her PhD dissertation to test Chen model and other competing models.
Following is the equational representation of the Chen Model:
drt = (ft – at)dt + vrtstdWt
In this formula:
dst = (ßt – st)dt + vst?tdWt, and
dat = (?t – at)dt + vatstdWt