Exact Formulas for Pricing Bonds and Options When Interest Rate Diffusions Contain Jumps

Posted: 22 Nov 2004

See all articles by John D. Finnerty

John D. Finnerty

Finnerty Economic Consulting LLC; Fordham University - Finance Area

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 further extend the models to coupon-bearing instruments by applying Jamshidian's serial-decomposition technique.

Keywords: Option pricing, bond pricing, diffusion, jumps

JEL Classification: G12, G13

Suggested Citation

Finnerty, John D., Exact Formulas for Pricing Bonds and Options When Interest Rate Diffusions Contain Jumps. Journal of Financial Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=559183

John D. Finnerty (Contact Author)

Finnerty Economic Consulting LLC ( email )

60 East 42nd Street
Suite 2910
New York, NY 10165
United States
2125991640 (Phone)
2125991242 (Fax)

HOME PAGE: http://www.finnecon.com

Fordham University - Finance Area ( email )

113 West 60th Street
New York, NY 10023
United States
2125991640 (Phone)
2125991242 (Fax)

HOME PAGE: http://www.finnecon.com

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