Analytical Valuation of American Options and Callable Bonds Under Stochastic Interest Rates and Endogenous Bankruptcy
Universidade de Évora
Colégio Espírito Santo - Sala 124
João Pedro Nunes (ISCTE)
Resumo / Abstract:
A new characterization of the American-style option is proposed under a multifactor Markovian and diffusion framework, which can accommodate both stochastic volatility and stochastic interest rates. The efficiency of the proposed pricing solution is shown to depend only on the use of a viable valuation method for the corresponding European-style option and for the transition density of the model’s state variables. Under a stochastic interest rates setup, the resulting American option pricing formula is shown to be as efficient as, but much more accurate than, the analytical approximate pricing solutions already proposed in the literature. This result is also used to obtain closed-form pricing solutions for callable corporate bonds under an endogenous bankruptcy setup.
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