Pricing interest rate options in a two-factor Cox-Ingersoll-Ross model of the term structure |
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Authors: | Chen, RR Scott, L |
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Affiliation: | 1 Rutgers University, USA 2 Department of Finance, Brook Hall, University of Georgia, Athens, GA 30602, USA z Corresponding author |
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Abstract: | Solutions are presented for prices on interest rate optionsin a two-factor version of the Cox-Ingersoll-Ross model of theterm structure. Specific solutions are developed for caps onfloating interest rates and for European options on discountbonds, coupon bonds, coupon bond futures, and Euro-dollar futures.The solutions for the options are expressed as multivariateintegrals, and we show how to reduce the calculations to univariatenumerical integrations, which can be calculated very quickly.The two-factor model provides more flexibility in fitting observedterm structures, and the fixed parameters of the model can beset to capture tie variability of the term structure over time. |
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