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Pricing real estate index options under stochastic interest rates

Listed author(s):
  • Gong, Pu
  • Dai, Jun
Registered author(s):

    Real estate derivatives as new financial instruments are not merely risk management tools but also provide a novel way to gain exposure to real estate assets without buying or selling the physical assets. Although real estate derivatives market has exhibited a rapid development in recent years, the valuation challenge of real estate derivatives remains a great obstacle for further development in this market. In this paper, we derive a partial differential equation contingent on a real estate index in a stochastic interest rate environment and propose a modified finite difference method that adopts the non-uniform grids to solve this problem. Numerical results confirm the efficiency of the method and indicate that constant interest rate models lead to the mispricing of options and the effects of stochastic interest rates on option prices depend on whether the term structure of interest rates is rising or falling. Finally, we have investigated and compared the different effects of stochastic interest rates on European and American option prices.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0378437117302327
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    Article provided by Elsevier in its journal Physica A: Statistical Mechanics and its Applications.

    Volume (Year): 479 (2017)
    Issue (Month): C ()
    Pages: 309-323

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    Handle: RePEc:eee:phsmap:v:479:y:2017:i:c:p:309-323
    DOI: 10.1016/j.physa.2017.03.009
    Contact details of provider: Web page: http://www.journals.elsevier.com/physica-a-statistical-mechpplications/

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    9. Dibeh, Ghassan & Harmanani, Haidar M., 2007. "Option pricing during post-crash relaxation times," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 380(C), pages 357-365.
    10. Chockalingam, Arun & Muthuraman, Kumar, 2015. "An approximate moving boundary method for American option pricing," European Journal of Operational Research, Elsevier, vol. 240(2), pages 431-438.
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