A Lattice Framework with Smooth Convergence for Pricing Real Estate Derivatives with Stochastic Interest Rate

Dong Zou and Pu Gong ()
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Dong Zou: Huazhong University of Science and Technology
Pu Gong: Huazhong University of Science and Technology

The Journal of Real Estate Finance and Economics, 2017, vol. 55, issue 2, No 5, 242-263

Abstract: Abstract In this paper, a general binomial lattice framework, which is both computationally simple and numerically accurate, is developed for pricing real estate derivatives with stochastic interest rate. To obtain a computationally simple binomial tree with constant volatility, the transformation method and the probability density matching approach are introduced. A tilt parameter is then added to the jump movements to obtain smooth convergence. Therefore, the Richardson extrapolation (RE) can be used to enhance the convergence of the discrete binomial lattice models to continuous models when pricing European options. In addition, our smooth convergent models can also be applied to pricing American options.

Keywords: Lattice framework; Real estate derivatives; Stochastic interest rate; Transformation method; Probability density matching approach; Smooth convergence (search for similar items in EconPapers)
JEL-codes: C65 G13 R31 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (3)

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DOI: 10.1007/s11146-016-9576-x

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