The short rate in the Ho-Lee model is given by :
drt=(df(0,t)dt+σ2t)dt+σdWt
I'm trying to find the bond dynamics given by :
dP(t,T)/P(t,T)=rtdt−σ(T−t)dWt
I started from :
P(t,T)=Et[e−∫Ttrsds]
and I applied Itô to the function P(t,T)=ϕ(t,r):
dϕ(t,r)=∂ϕ(t,r)∂tdt+∂ϕ(t,r)∂rdrt+12∂2ϕ(t,r)∂r2(drt)2
I computed the derivatives :
∂ϕ(t,r)∂t=rtP(t,T)
∂ϕ(t,r)∂r=−(T−t)P(t,T)
12∂2ϕ(t,r)∂r2=(T−t)2P(t,T)
Assembling everything I get :
dP(t,T)/P(t,T)=rtdt−(T−t)σdWt+[12(T−t)2σ2−(T−t)(df(0,t)dt+σ2t)]dt
I don't know how to get rid of the last dt term. Any Help? Or did I get the derivatives wrong? I checked them several times but I don't see where the probem comes from. Thank you
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