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A Lattice Framework with Smooth Convergence for Pricing Real Estate Derivatives with Stochastic Interest Rate

Author

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  • Dong Zou

    (Huazhong University of Science and Technology)

  • Pu Gong

    (Huazhong University of Science and Technology)

Abstract

In this paper, a general binomial lattice framework, which is both computationally simple and numerically accurate, is developed for pricing real estate derivatives with stochastic interest rate. To obtain a computationally simple binomial tree with constant volatility, the transformation method and the probability density matching approach are introduced. A tilt parameter is then added to the jump movements to obtain smooth convergence. Therefore, the Richardson extrapolation (RE) can be used to enhance the convergence of the discrete binomial lattice models to continuous models when pricing European options. In addition, our smooth convergent models can also be applied to pricing American options.

Suggested Citation

  • Dong Zou & Pu Gong, 2017. "A Lattice Framework with Smooth Convergence for Pricing Real Estate Derivatives with Stochastic Interest Rate," The Journal of Real Estate Finance and Economics, Springer, vol. 55(2), pages 242-263, August.
    • Handle: RePEc:kap:jrefec:v:55:y:2017:i:2:d:10.1007_s11146-016-9576-x
    DOI: 10.1007/s11146-016-9576-x
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    References listed on IDEAS

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    Cited by:

    1. Gong, Pu & Zou, Dong & Wang, Jiayue, 2018. "Pricing and simulation for real estate index options: Radial basis point interpolation," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 500(C), pages 177-188.
    2. Xubiao He & Pu Gong, 2020. "A Radial Basis Function-Generated Finite Difference Method to Evaluate Real Estate Index Options," Computational Economics, Springer;Society for Computational Economics, vol. 55(3), pages 999-1019, March.

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    More about this item

    Keywords

    Lattice framework; Real estate derivatives; Stochastic interest rate; Transformation method; Probability density matching approach; Smooth convergence;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets
    • C65 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Miscellaneous Mathematical Tools

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