EXACT FORMULAS FOR PRICING BONDS AND OPTIONS WHEN INTEREST RATE DIFFUSIONS CONTAIN JUMPS

John D. Finnerty

Journal of Financial Research, 2005, vol. 28, issue 3, 319-341

Abstract: I develop Heath‐Jarrow‐Morton extensions of the Vasicek and Jamshidian pure‐diffusion models, extend these models to incorporate Poisson‐Gaussian interest rate jumps, and obtain closed‐form models for valuing default‐free, zero‐coupon bonds and European call and put options on default‐free, zero‐coupon bonds in a market where interest rates can experience discontinuous information shocks. The jump‐diffusion pricing models value the instrument as the probability‐weighted average of the pure‐diffusion model prices, each conditional on a specific number of jumps occurring during the life of the instrument. I extend the models to coupon‐bearing instruments by applying Jamshidian's serial‐decomposition technique.

Date: 2005
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https://doi.org/10.1111/j.1475-6803.2005.00127.x

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