Bond option pricing under the CKLS model
Consider the European call option written on a zero coupon bond. Suppose the call option has maturity T and strike price K while the bond has maturity S T . We propose a numerical method for evaluating the call option price under the Chan, Karolyi, Longstaff and Sanders (CKLS) model in which t...
| Main Authors: | , , |
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| Format: | Conference or Workshop Item |
| Language: | English |
| Published: |
2012
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| Subjects: | |
| Online Access: | http://eprints.sunway.edu.my/200/ http://eprints.sunway.edu.my/200/1/Pooi%20Ah%20Hin%20-%20Bond%20option%20pricing%20under%20the%20CKLS%20model.pdf |
| Summary: | Consider the European call option written on a zero
coupon bond. Suppose the call option has maturity T and
strike price K while the bond has maturity S T . We propose a numerical method for evaluating the call option
price under the Chan, Karolyi, Longstaff and Sanders (CKLS)
model in which the increment of the short rate over a time
interval of length dt , apart from being independent and
stationary, is having the quadratic-normal distribution with
mean zero and variance dt. The key steps in the numerical
procedure include (i) the discretization of the CKLS model;
(ii) the quadratic approximation of the time-T bond price as a function of the short rate rT at time T; and (iii) the
application of recursive formulas to find the moments of
r(t+dt) given the value of r(t). The numerical results thus
found show that the option price decreases as the parameter
in the CKLS model increases, and the variation of the
option price is slight when the underlying distribution of the increment departs from the normal distribution. |
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