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The influence of a stochastic interest rate on the n-fold compound option

  • THOMASSEN, Liesbeth
  • VAN WOUWE, Martine

We reintroduced the idea of an n-fold compound option as a generalization of Geske’s (2- fold) compound option in the same framework of constant interest rates. For the valuation of long-term financial agreements (life insurance products) this assumption is not always realistic. So that the stochastic modelling of the interest rates might be a better approach. According to Miltersen et al., we will use the requirement of simple interest rates over a fixed finite period to be log-normal distributed, instead of the continuously compounded interest rates. With these assumptions, closed-form solutions are determined for the n-fold compound call options written on zero-coupon bonds.

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File URL: https://www.uantwerpen.be/images/uantwerpen/container1244/files/TEW%20-%20Onderzoek/Working%20Papers/RPS/2003/RPS-2003-010.pdf
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Paper provided by University of Antwerp, Faculty of Applied Economics in its series Working Papers with number 2003010.

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Length: 15 pages
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Handle: RePEc:ant:wpaper:2003010
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Web page: https://www.uantwerp.be/en/faculties/applied-economic-sciences/

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  1. Miltersen, K. & K. Sandmann & D. Sondermann, 1994. "Closed Form Solutions for Term Structure Derivatives with Log-Normal Interest Rates," Discussion Paper Serie B 308, University of Bonn, Germany.
  2. THOMASSEN, Liesbeth & VAN WOUWE, Martine, . "The n-fold compound option," Working Papers 2001041, University of Antwerp, Faculty of Applied Economics.
  3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  4. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
  5. D. Sondermann & Sandmann, K., 1994. "On the Stability of Log-Normal Interest Rate Models and the Pricing of Eurodollar Futures," Discussion Paper Serie B 263, University of Bonn, Germany.
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