Valuation of Two-Factor Interest Rate Contingent Claims Using Green's Theorem

Ghulam Sorwar and Giovanni Barone-Adesi

Applied Mathematical Finance, 2011, vol. 18, issue 4, 277-289

Abstract: Over the years a number of two-factor interest rate models have been proposed that have formed the basis for the valuation of interest rate contingent claims. This valuation equation often takes the form of a partial differential equation that is solved using the finite difference approach. In the case of two-factor models this has resulted in solving two second-order partial derivatives leading to boundary errors, as well as numerous first-order derivatives. In this article we demonstrate that using Green's theorem, second-order derivatives can be reduced to first-order derivatives that can be easily discretized; consequently, two-factor partial differential equations are easier to discretize than one-factor partial differential equations. We illustrate our approach by applying it to value contingent claims based on the two-factor CIR model. We provide numerical examples that illustrate that our approach shows excellent agreement with analytical prices and the popular Crank-Nicolson method.

Keywords: Box method; derivatives; Green's theorem (search for similar items in EconPapers)
Date: 2011
References: Add references at CitEc
Citations:

Downloads: (external link)
http://www.tandfonline.com/doi/abs/10.1080/1350486X.2010.531588 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:taf:apmtfi:v:18:y:2011:i:4:p:277-289

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/RAMF20

DOI: 10.1080/1350486X.2010.531588

Access Statistics for this article

Applied Mathematical Finance is currently edited by Professor Ben Hambly and Christoph Reisinger

More articles in Applied Mathematical Finance from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().