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Efficient Solutions for Pricing and Hedging Interest Rate Asian Options

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  • Allan Jonathan da Silva
  • Jack Baczynski
  • José Valentim Machado Vicente

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.

Suggested Citation

  • Allan Jonathan da Silva & Jack Baczynski & José Valentim Machado Vicente, 2020. "Efficient Solutions for Pricing and Hedging Interest Rate Asian Options," Working Papers Series 513, Central Bank of Brazil, Research Department.
    • Handle: RePEc:bcb:wpaper:513
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    References listed on IDEAS

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