Article,

Bond Option Valuation for Non-Markovian Interest Rate Processes

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Financial Review, 40 (4): 519--532 (2005)
DOI: 10.1111/j.1540-6288.2005.00122.x

Abstract

The standard method for valuing a European option on a bond portfolio is developed by Jamshidian. He shows that under certain circumstances the payoff from a bond option can be expressed as a portfolio of payoffs on discount bond options, allowing the option to be valued as a portfolio of options. A limitation of this approach is that it cannot be applied to non-Markovian interest rate processes. This paper develops a method for the valuation of a European option on a bond portfolio that can be applied to both Markovian and non-Markovian interest rate processes.

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