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I have an American option on a credit prepayment, i.e. the holder of the option can prepay the remaining credit if the interest rate falls below the initial strike. The pricing of this option was done on a discrete lattice (binomial tree) assuming that a risk-free part of the interest rate follows the one-factor Vasicek short rate model.

I was told that Vasicek on a tree is a terrible choice of model implementation and that one should either use Monte Carlo simulation with the Vasicek model or use the Hull-White model on a tree. I was also told that this is a bad practice in general to use one-factor models on trees. Can anyone elaborate on it?

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    $\begingroup$ Both models are mean reverting, so the direction and intensity of their movements depend on the long term mean of the value. As a result, you can get negative values when the value is higher than the long term mean. If you want to use a tree with these models, then it will need to be modified to account for this. This either adds another layer of complexity and/or lowers accuracy. Today, people generally use Monte Carlo simulations instead of trees because they are more efficient. $\endgroup$
    – Kevin K.
    Aug 10, 2021 at 19:15
  • $\begingroup$ @KevinK., can you give a link to any source with discussion of the tree modifications needed? $\endgroup$
    – Hasek
    Aug 11, 2021 at 7:33

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