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Time-Dependent Variance and the Pricing of Bond Options

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  • Schaefer, Stephen M
  • Schwartz, Eduardo S
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    Abstract

    In this paper, the authors develop a model for valuing debt options which 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-Schwartz models. Copyright 1987 by American Finance Association.

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    Bibliographic Info

    Article provided by American Finance Association in its journal Journal of Finance.

    Volume (Year): 42 (1987)
    Issue (Month): 5 (December)
    Pages: 1113-28

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    Handle: RePEc:bla:jfinan:v:42:y:1987:i:5:p:1113-28

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    Cited by:
    1. David K. Backus & Stanley E. Zin, 1994. "Reverse Engineering the Yield Curve," Working Papers 94-09, New York University, Leonard N. Stern School of Business, Department of Economics.
    2. Pham, Toan M., 1998. "Estimation of the term structure of interest rates: an international perspective," Journal of Multinational Financial Management, Elsevier, vol. 8(2-3), pages 265-283, September.
    3. John Barkoulas & Christopher F. Baum & Atreya Chakraborty, 1996. "Nearest-Neighbor Forecasts of U.S. Interest Rates," Boston College Working Papers in Economics 313., Boston College Department of Economics, revised 01 Apr 2003.
    4. Rama Cont, 1999. "Modeling interest rate dynamics: an infinite-dimensional approach," Papers cond-mat/9902018, arXiv.org.

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