The pricing of Asian options under stochastic interest rates

J. A. Nielsen and Klaus Sandmann

Applied Mathematical Finance, 1996, vol. 3, issue 3, 209-236

Abstract: The purpose of this paper is to analyse the effect of stochastic interest rates on the pricing of Asian options. It is shown that a stochastic, in contrast to a deterministic, development of the term structure of interest rates has a significant influence. The price of the underlying asset, e.g. a stock or oil, and the prices of bonds are assumed to follow correlated two-dimensional Ito processes. The averages considered in the Asian options are calculated on a discrete time grid, e.g. all closing prices on Wednesdays during the lifetime of the contract. The value of an Asian option will be obtained through the application of Monte Carlo simulation, and for this purpose the stochastic processes for the basic assets need not be severely restricted. However, to make comparison with published results originating from models with deterministic interest rates, we will stay within the setting of a Gaussian framework.

Keywords: Asian options; forward risk adjusted measure; Monte Carlo simulation (search for similar items in EconPapers)
Date: 1996
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Citations: View citations in EconPapers (11)

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DOI: 10.1080/13504869600000011

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