“The real challenge was to model all the interest rates simultaneously, so you could value something that depended not only on the three-month interest rate, but on other interest rates as well.”
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I think VAR is a very healthy development within the industry.
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There are challenges in terms of the measurement of VAR for what are known as nonlinear derivatives, where things like gamma and vega are important dimensions of the risk.
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In the interest rate area, traders have for a long time used a version of what is known as Black's model for European bond options; another version of the same model for caps and floors; and yet another version of the same model for European swap options.
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The HoLee model was the first term structure model. I remember reading their paper soon after it was published and as it was fairly different from many of the other papers that I had read, I had to read it quite a few times. I realized that it was a really important paper.
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