A simple approach to bond option pricing

Wei, Jason Zhanshun

doi:10.1002/(sici)1096-9934(199704)17:2<131::aid-fut1>3.0.co;2-k

Cited by 34 publications

(17 citation statements)

References 28 publications

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“…In a one-factor framework, Wei (1997) suggests that the price of a European call option on a coupon bond can be approximated by a multiple of the price of a European call option on a zero-coupon bond with a time to maturity equal to the stochastic duration of the coupon bond. Let C(t; t * , T, X ) be the time t price of a European call option maturing at time t * , written on a zero-coupon bond paying one dollar at time T , and having an exercise price of X .…”

Section: The General Idea Of the Approximationmentioning

confidence: 99%

“…Wei (1997) shows by numerical examples that in the Vasicek and CIR one-factor models the price of a European coupon bond option is very closely approximated by a multiple of the price of a European option on the zero-coupon bond having a time to maturity equal to the stochastic duration of the coupon bond. Closed-form solutions for the prices of European coupon bond options do exist in these models, cf.…”

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confidence: 99%

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Stochastic Duration and Fast Coupon Bond Option Pricing in Multi-Factor Models

Munk

1998

SSRN Journal

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Abstract. Generalizing Cox, Ingersoll, and Ross (1979), this paper defines the stochastic duration of a bond in a general multi-factor diffusion model as the time to maturity of the zero-coupon bond with the same relative volatility as the bond. Important general properties of the stochastic duration measure are derived analytically, and the stochastic duration is studied in detail in various well-known models. It is also demonstrated by analytical arguments and numerical examples that the price of a European option on a coupon bond (and, hence, of a European swaption) can be approximated very accurately by a multiple of the price of a European option on a zero-coupon bond with a time to maturity equal to the stochastic duration of the coupon bond.

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Section: The General Idea Of the Approximationmentioning

confidence: 99%

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confidence: 99%

Stochastic Duration and Fast Coupon Bond Option Pricing in Multi-Factor Models

Munk

1998

SSRN Journal

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“…The minimum variance duration approach has been shown to give highly accurate approximation solution to an option on coupon bearing bond under the multi-factor interest rate model. Recall that the stochastic duration of a coupon bearing bond in a multi-factor diffusion model is defined to be the time to maturity of the zero-coupon bond with the same relative volatility as that of the coupon bearing bond (Wei, 1997). The minimum variance duration may be considered as an extension of the concept of stochastic duration.…”

Section: Methods Of Minimum Variance Durationmentioning

confidence: 99%

“…which is just the stochastic duration of the annuity (Wei, 1997). For the general multifactor case, the minimization of var…”

Section: Determination Of τ Using Minimization Of Variance Durationmentioning

confidence: 99%

“…One method uses a single zero-coupon bond as a proxy for the original coupon-bearing bond. The approximation error is minimized by choosing the maturity of the zero-coupon bond to be equal to the stochastic duration (Cox et al, 1979;Wei, 1997) of the coupon-bearing bond. Another method makes use of the Edgeworth approximation of the probability distribution of the value of the coupon-bearing bond (Collin-Dufresne and Goldstein, 2002).…”

Section: Introductionmentioning

confidence: 99%

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Valuation of Guaranteed Annuity Options in Affine Term Structure Models

Chu

Kwok

2007

Int. J. Theor. Appl. Finan.

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We propose three analytic approximation methods for numerical valuation of the guaranteed annuity options in deferred annuity pension policies. The approximation methods include the stochastic duration approach, Edgeworth expansion and analytic approximation in affine diffusions. The payoff structure in the annuity policies is similar to a quanto call option written on a coupon bearing bond. To circumvent the limitations of the onefactor interest rate model, we model the interest rate dynamics by a two-factor affine interest rate term structure model. The numerical accuracy and computational efficiency of these approximation methods are analyzed. We also investigate the value sensitivity of the guaranteed annuity option with respect to different parameters in the pricing model. JEL classification: G13; G23

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2016

Manufacturing and Managing Customer‐Driven Derivatives

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A simple approach to bond option pricing

Cited by 34 publications

References 28 publications

Stochastic Duration and Fast Coupon Bond Option Pricing in Multi-Factor Models

Stochastic Duration and Fast Coupon Bond Option Pricing in Multi-Factor Models

Valuation of Guaranteed Annuity Options in Affine Term Structure Models

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