Article1995

Lattice Models for Pricing American Interest Rate Claims

Anlong Li · Peter H. Ritchken · L. Sankarasubramanian

81 citations0/0 files storedThe Journal of Finance

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Stochastic processes and financial applications Financial Markets and Investment Strategies Economic theories and models

Abstract

ABSTRACT This article establishes efficient lattice algorithms for pricing American interest‐sensitive claims in the Heath, Jarrow, and Morton paradigm, under the assumption that the volatility structure of forward rates is restricted to a class that permits a Markovian representation of the term structure. The class of volatilities that permits this representation is quite large and imposes no severe restrictions on the structure for the spot rate volatility. The algorithm exploits the Markovian property of the term structure and permits the efficient computation of all types of interest rate claims. Specific examples are provided.

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References

1985A Theory of the Term Structure of Interest Rates 1977An equilibrium characterization of the term structure 1992Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation 1990Pricing Interest-Rate-Derivative Securities 1992An Empirical Comparison of Alternative Models of the Short-Term Interest Rate 1990A One-Factor Model of Interest Rates and Its Application to Treasury Bond Options 1989An Exact Bond Option Formula 1991Bond and Option Pricing when Short Rates are Lognormal

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2002Convergence of numerical methods for valuing path-dependent options using interpolation 1997Recent Advances in Numerical Methods for Pricing Derivative Securities 2000Interest rate option pricing with volatility humps 1997Pricing American interest rate claims with humped volatility models 2004Review Paper. Interest–rate term–structure pricing models: a review 1998A direct discrete-time approach to Poisson–Gaussian bond option pricing in the Heath–Jarrow–Morton model

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