Discrete-Time Valuation of American Options with Stochastic Interest Rates

Posted: 26 Oct 1999

See all articles by Kaushik I. Amin

Kaushik I. Amin

Lehman Brothers

James N. Bodurtha

Georgetown University - Department of Finance

Abstract

We develop an arbitrage-free discrete time model to price American-style claims for which domestic term structurerisk, foreign term structure risk and currency risk are important. This model combines a discrete version of the Heath, Jarrow, Morton (1992) term structure model with the binomial model of Cox, Ross, and Rubinstein (1979). It converges (weakly) to the continuous time models in Amin and Jarrow (1991, 1992). The general model is "path dependent" and can be implemented with arbitrary volatility functions to value claims with maturity up to five years. The model is illustrated with applications to long-dated American currency warrants and a cross-rate swap from the quanto class.

JEL Classification: G12, G13

Suggested Citation

Amin, Kaushik I. and Bodurtha, James N., Discrete-Time Valuation of American Options with Stochastic Interest Rates. Available at SSRN: https://ssrn.com/abstract=5398

Kaushik I. Amin

Lehman Brothers ( email )

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James N. Bodurtha (Contact Author)

Georgetown University - Department of Finance ( email )

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