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Time‐Dependent Variance and the Pricing of Bond Options
Author(s) -
SCHAEFER STEPHEN M.,
SCHWARTZ EDUARDO S.
Publication year - 1987
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1987.tb04356.x
Subject(s) - bond , bond valuation , black–scholes model , robustness (evolution) , economics , econometrics , variable (mathematics) , variance (accounting) , standard deviation , valuation of options , mathematical economics , mathematics , volatility (finance) , statistics , finance , mathematical analysis , biochemistry , chemistry , accounting , gene
In this paper, we develop a model for valuing debt options that takes into account the changing characteristics of the underlying bond by assuming that the standard deviation of return is proportional to the bond's duration. The resulting model uses the bond price as the single state variable and thus preserves much of the simplicity and robustness of the Black‐Scholes approach. The paper provides comparisons between option prices computed using this model and those using the Black‐Scholes and Brennan and Schwartz models.