Explain the volatility property found in an interest-rate model

What will be an ideal response?

The volatility term refers to that variability of the interest rate or the short rate. The symbol ? is used in interest rate models to represent the volatility and is simply the standard deviation of the changes in the short rate. Like the drift term, assumptions are made such as its dependency on the level of the short rate. There have been several formulations of the dynamics of the volatility term. If volatility is assumed to depend on time, then we express volatility as?(r,t) where r is the short rate and t is the change in time (or time period being considered). If volatility is not assumed to depend on time, then ?(r,t) = ?(r).In general, the dynamics of the volatility term can be specified as?r?dzwhere ? is equal to the constant elasticity of variance. This equation is called the constant elasticity of variance model (CEV model).