The Pricing of Asian Options Under Stochastic Interest Rates

Posted: 13 Jul 1998

See all articles by J. Aase Nielsen

J. Aase Nielsen

Aarhus University - Department of Theoretical Statistics and Operations Research

Klaus Sandmann

University of Bonn - The Bonn Graduate School of Economics

Abstract

The purpose of this paper is to analyse the effect of stochastic interest rates on the pricing of Asian options. It is shown that a stochastic, in contrast to a deterministic, development of the term structure of interest rates has a significant influence. The price of the underlying asset, e.g. a stock or oil, and the prices of bonds are assumed to follow correlated two dimensional Ito processes. The averages considered in the Asian options are calculated on a discrete time grid, e.g. all closing prices on Wednesdays during the lifetime of the contract. The value of an Asian option will be obtained through the application of Monte Carlo simulation, and for this purpose the stochastic processes for the basic assets need not be severely restricted. However to make comparison with published results originating from models with deterministic interest rates we will stay within the setting of a Gaussian framework.

JEL Classification: G13

Suggested Citation

Nielsen, Jørgen Aase and Sandmann, Klaus, The Pricing of Asian Options Under Stochastic Interest Rates. Applied Mathematical Finance, Vol. 3, No. 3, pp. 209-236, 1995. Available at SSRN: https://ssrn.com/abstract=7025

Jørgen Aase Nielsen

Aarhus University - Department of Theoretical Statistics and Operations Research ( email )

DK-8000 Aarhus C
Denmark

Klaus Sandmann (Contact Author)

University of Bonn - The Bonn Graduate School of Economics ( email )

Adenauerallee 24-26
Bonn, D-53113
Germany

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