This paper studies the pricing of interest rate options using no-arbitrage models and carries out the pricing of the equilibrium price of the bonds and the interest rate options. From a theoretical and computational perspective, it is so much desirable using a no-arbitrage model that is Markov and fits the initial term structure when valuing interest rate derivatives securities. We find the equilibrium price of the bonds depends on the long-term level of the interest rate, the volatilities of the instantaneous short rate, and the reversion speed to the long-term level of rate.
