An exact pricing formula for European call options on zero-coupon bonds in the run-up to a currency union

Gerrit Reher and Bernd Wilfling

No 1010, CQE Working Papers from Center for Quantitative Economics (CQE), University of Muenster

Abstract: In this paper we analyze the dynamics of zero-coupon bond options in a situation in which two open economies plan to enter a currency union in the future. More precisely, we make use of recent theoretical work on the continuous-time dynamics of interest-rate differentials between the economies involved and derive a closed-form pricing formula for a European call option on zero-coupon bonds. In a Monte-Carlo simulation study we show that significant option-pricing errors can occur when the key features of interest-rate dynamics during the run-up to the currency union are ignored.

Keywords: Interest-rate dynamics; valuation of interest-rate options; currency union (search for similar items in EconPapers)
JEL-codes: E42 F37 G12 G13 G15 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2010-01
New Economics Papers: this item is included in nep-cfn and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:cqe:wpaper:1010

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