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I have been scratching my head over this question, but could not find out an answer. Can anyone explain how is term structure reflected from a short rate model?

Specifically, if we have a stochastic differential equation for dR(t). It is possible calculate the one year rate, two year rate three year rate etc from the integrals $\int_o^tR(t)dt$. However, how do we make sure that the two year rate is bigger than the one year rate?

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  • $\begingroup$ you want to fit a term-structure ? $\endgroup$ – MJ73550 Aug 8 '16 at 14:05
  • $\begingroup$ I was thinking about the setup and am wondering how a short rate model makes sure that the two year rate is bigger than the one year rate? $\endgroup$ – user1559897 Aug 8 '16 at 14:08
  • $\begingroup$ I think you want your short rate model to be able to fit an inverted curve as well since it can happen en.wikipedia.org/wiki/Yield_curve#/media/… $\endgroup$ – MJ73550 Aug 8 '16 at 14:12

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