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Exact Formulas For Pricing Bonds And Options When Interest Rate Diffusions Contain Jumps

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  • John D. Finnerty

Abstract

I develop Heath-Jarrow-Morton extensions of the Vasicek and Jamshidian pure-diffusion models, extend these models to incorporate Poisson-Gaussian interest rate jumps, and obtain closed-form models for valuing default-free, zero-coupon bonds and European call and put options on default-free, zero-coupon bonds in a market where interest rates can experience discontinuous information shocks. The jump-diffusion pricing models value the instrument as the probability-weighted average of the pure-diffusion model prices, each conditional on a specific number of jumps occurring during the life of the instrument. I extend the models to coupon-bearing instruments by applying Jamshidian's serial-decomposition technique. 2005 The Southern Finance Association and the Southwestern Finance Association.

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  • John D. Finnerty, 2005. "Exact Formulas For Pricing Bonds And Options When Interest Rate Diffusions Contain Jumps," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 28(3), pages 319-341.
  • Handle: RePEc:bla:jfnres:v:28:y:2005:i:3:p:319-341
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