We propose a new derivation of the Heath–Jarrow–Morton risk-neutral drift restriction that takes into account nonzero instantaneous correlations between factors. The result allows avoiding the orthogonalization of factors and provides an approach by which interest rate derivatives can be...

The market model of interest rates specifies simple forward or Libor rates as lognormally distributed, their stochastic dynamics has a linear volatility function. In this paper, the model is extended to quadratic volatility functions which are the product of a quadratic polynomial and a...