Interest Rate Options in Multi-Factor Cox-Ingersoll-Ross Models of the Term Structure

Posted: 25 Aug 1998

See all articles by Ren-Raw Chen

Ren-Raw Chen

Fordham University - Gabelli School of Business

Louis Scott

Morgan Stanley - United Kingdom Office

Abstract

Fast closed form solutions using Fourier inversion methods are developed for interest rate options in multi-factor versions of the Cox-Ingersoll-Ross model. The options include European options on discount bonds, European options on Eurodollar futures, and caps on floating interest rates. Valuation models for options on coupon bonds and coupon bond futures are also discussed. The multi-factor Cox-Ingersoll-Ross models generate prices for interest rate options that differ significantly from prices generated by Black's model when options with long term expirations are valued. When a multi-factor model is used for hedging, the hedge portfolio requires additional securities and conventional formulas for hedge ratios must be modified.

JEL Classification: G12, G13, G14

Suggested Citation

Chen, Ren-Raw and Scott, Louis, Interest Rate Options in Multi-Factor Cox-Ingersoll-Ross Models of the Term Structure. Available at SSRN: https://ssrn.com/abstract=6556

Ren-Raw Chen

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
Bronx, NY 10458
United States

Louis Scott (Contact Author)

Morgan Stanley - United Kingdom Office ( email )

Cabot Square, Canary Whart
London, E14 4QW
United Kingdom
44 207 425 6581 (Phone)

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