The Valuation of Interest Rate Digital Options and Range Notes Revisited

Patrick Navatte and François Quittard‐Pinon

European Financial Management, 1999, vol. 5, issue 3, 425-440

Abstract: The aim of this paper is to value interest rate structured products in a simpler and more intuitive way than Turnbull (1995). Considering some assumptions with respect to the evolution of the term structure of interest rates, the price of a European interest rate digital call option is given. Recall it is a contract designed to pay one dollar at maturity if a reference interest rate is above a prespecified level (the strike), and zero in all the others cases. Combining two options of this type enables us to value a European range digital option. Then using a one factor linear gaussian model and the new well‐known change of numeraire approach, a closed‐form formula is found to value range notes which pay at the end of each defined period, a sum equal to a prespecified interest rate times the number of days the reference interest rate lies inside a corridor.

Date: 1999
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https://doi.org/10.1111/1468-036X.00103

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Working Paper: The Valuation of Interest Rate Digital Options and Range Notes Revisited (1999)
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