An analytically tractable interest rate model with humped volatility

Some of the most recent empirical studies on interest rate derivatives have found humped shapes in the volatility structure of interest rates. However, this realistic feature has been hardly addressed in theoretical works. In this paper, we propose an interest rate model which allows for a humped volatility structure and which is analytically tractable, in that it leads to explicit formulae for European options on discount bonds. Empirical evidence supporting the model is also provided.