Interest Rate, Currency and Equity Derivatives Valuation Using the Potential Approach

Naosuke Nakamura and Fan Yu

International Review of Finance, 2000, vol. 1, issue 4, 269-294

Abstract: Based on the potential approach to interest rate modelling, we introduce a simple tractable model for the unified valuation of interest rate, currency and equity derivatives. Our model is able to accommodate the initial term structure of zero‐coupon bond prices, generate positive and bounded interest rates, and handle cross products such as differential swaps, quanto options and equity swaps. As our model is specified under the actual probability measure, it can be directly used for portfolio risk management and the computation of value at risk. Furthermore, our model yields simple analytical formulas that are easy to calibrate and implement.

Date: 2000
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