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Lattice Models for Pricing American Interest Rate Claims
Author(s) -
LI ANLONG,
RITCHKEN PETER,
SANKARASUBRAMANIAN L.
Publication year - 1995
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.1540-6261.1995.tb04802.x
Subject(s) - computation , volatility (finance) , interest rate , forward rate , interest rate derivative , lattice (music) , markov process , computer science , representation (politics) , statistical physics , mathematics , algorithm , econometrics , economics , finance , statistics , physics , acoustics , politics , political science , law
This article establishes efficient lattice algorithms for pricing American interest‐sensitive claims in the Heath, Jarrow, and Morton paradigm, under the assumption that the volatility structure of forward rates is restricted to a class that permits a Markovian representation of the term structure. The class of volatilities that permits this representation is quite large and imposes no severe restrictions on the structure for the spot rate volatility. The algorithm exploits the Markovian property of the term structure and permits the efficient computation of all types of interest rate claims. Specific examples are provided.