Shadow Rate

The original paper by Gorovoi and Linetsky, and a summary of it, is a pretty neat idea to resolve the shortcoming of Gaussian short rate models: that the interest rate can go below zero (but should we be concerned about negative rate, now that CHF Libor has seen negative values?).

The 'shadow rate,' which is a latent unobservable process, is still assumed to be Gaussian. The true short rate process is floored at zero of the latent process. Intuitively, people can always choose to hold cash when rate is below zero so the effective rate should never drop to negative.

They also use an eigenfunction expansion method to construct the solution to the PDE (derivative price).