A multi-factor valuation model which is designed to price interest rate options (broadly interest rate derivatives) and specific credit derivatives using actual interest rate term structures and volatility formulas. This option pricing model is used to construct forward interest rates under no-arbitrage assumption using a differential equation that allows for randomness (the so-called stochastic partial differential equation). In such an environment, these interest rates are constructed using an real-life term structure of interest rates to reach at proper pricing for interest rate products (such as bonds or swaps and interest rate options).

The Heath-Jarrow-Morton model (for shot HJM model) allows the volatility to freely change in reaction to changes in the forward interest rate, time to maturity and the forward spread. For that purpose, the volatility is a power function of the forward rate for the short term, while it lines up in a U-shape curve for the long term. Overall, volatility negatively correlates with time to maturity, and therefore the forward spread would have a significant effect only for short maturities.

The Heath-Jarrow-Morton model was established based on the framework developed by David Heath, Robert A. Jarrow, and Andrew Morton during the late 1980s.