Eurodollar futures pricing in log-normal interest rate models in discrete time

Dan Pirjol

Applied Mathematical Finance, 2016, vol. 23, issue 6, 445-464

Abstract: We demonstrate the appearance of explosions in three quantities in interest rate models with log-normally distributed rates in discrete time. (1) The expectation of the money market account in the Black, Derman, Toy model, (2) the prices of Eurodollar futures contracts in a model with log-normally distributed rates in the terminal measure and (3) the prices of Eurodollar futures contracts in the one-factor log-normal Libor market model (LMM). We derive exact upper and lower bounds on the prices and on the standard deviation of the Monte Carlo pricing of Eurodollar futures in the one factor log-normal Libor market model. These bounds explode at a non-zero value of volatility, and thus imply a limitation on the applicability of the LMM and on its Monte Carlo simulation to sufficiently low volatilities.

Date: 2016
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DOI: 10.1080/1350486X.2017.1297727

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