This paper describes the interest rate model developed by Ritchken and Sankarasubramanian. This model belongs to the Heath-Jarrow-Morton paradigm. Unlike the general Heath-Jarrow-Morton model, this model is Markovian model. Ritchken and Sankarasubramanian identifies the conditions on the volatility structure of forward rates that permit the dynamics of the term structure to be represented by two-dimensional state variable Markov process. This model has a useful property to reconstruct the term structure of interest rates at every node using two state variables. This property permits us efficient lattice methods for pricing all types of interest rate claims including American features. This paper shows that Ritchken-Sankarasubramanian model is applicable to the valuation of path-dependent securities such as mortgage-backed securities.
