Development of computational algorithms for pricing European bond options under the influence of macro-economic conditions

Jia-Ping Huang and Ushio Sumita

Applied Mathematics and Computation, 2015, vol. 251, issue C, 453-468

Abstract: In this paper, a stochastic process of Vasicek type describing the short rate is considered, where the three governing parameters {ϕ,α,σ}, with ϕ for the market fitting, α for the reversion and σ for the volatility, would depend on the macro-economic condition modeled as an independent birth–death process on a finite state space. Computational algorithms are developed for evaluating the prices of European call options defined on a zero-coupon discount bond characterized by the above stochastic process. Numerical examples are provided based on real data so as to demonstrate the speed and efficiency of the proposed algorithms.

Keywords: Markov process; Vasicek model; Ornstein–Uhlenbeck process; Bond option pricing; Regime-switching (search for similar items in EconPapers)
Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:eee:apmaco:v:251:y:2015:i:c:p:453-468

DOI: 10.1016/j.amc.2014.11.071

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