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Efficient Solutions for Pricing and Hedging Interest Rate Asian Options

Allan Silva, Jack Baczynski and José Vicente

No 513, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: We develop analytical solutions for the characteristic function of the integrated short-term rate process using the Fourier-cosine series. The method allows us to study the pricing of Asian interest rate options for a broad class of affine jump-diffusion models. In particular, we provide closed-form Fourier-cosine series representations for the price and the delta-hedge of Asian interest rate options under the augmented Vasicek model. In a numerical study, we show that Asian interest rate option prices can be accurately and efficiently approximated by truncating their series representations. The proposed procedure is calculated fast and is superior in accuracy when compared to the existing numerical methods used to price Asian interest rate options.

Date: 2020-01
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