Bond option pricing under the CKLS model

Khor, C. Y. and Pooi, Ah Hin * and Ng, K. H. (2012) Bond option pricing under the CKLS model. In: Regional Conference on Applied and Engineering Mathematics (2nd). Proceedings, 30 - 31 May 2012, Penang.

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Pooi Ah Hin - Bond option pricing under the CKLS model.pdf - Accepted Version

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Abstract

Consider the European call option written on a zero coupon bond. Suppose the call option has maturity T and strike price K while the bond has maturity S  T . We propose a numerical method for evaluating the call option price under the Chan, Karolyi, Longstaff and Sanders (CKLS) model in which the increment of the short rate over a time interval of length dt , apart from being independent and stationary, is having the quadratic-normal distribution with mean zero and variance dt. The key steps in the numerical procedure include (i) the discretization of the CKLS model; (ii) the quadratic approximation of the time-T bond price as a function of the short rate rT  at time T; and (iii) the application of recursive formulas to find the moments of r(t+dt) given the value of r(t). The numerical results thus found show that the option price decreases as the parameter  in the CKLS model increases, and the variation of the option price is slight when the underlying distribution of the increment departs from the normal distribution.

Item Type: Conference or Workshop Item (Paper)
Additional Information: First author with Faculty of Computing and Informatics, Multimedia University; 2nd author with Sunway University Business School; 3rd author with Institute of Mathematical Sciences, Faculty of Science, University of Malaya.
Uncontrolled Keywords: zero coupon bond; CKLS model; option price
Subjects: H Social Sciences > HG Finance
Q Science > QA Mathematics
Divisions: Others > Non Sunway Academics
Sunway University > Sunway University Business School > Dept. Financial Mathematics & Statistics
Depositing User: Ms. Molly Chuah
Date Deposited: 11 Jan 2014 14:29
Last Modified: 11 Jan 2014 14:29
URI: http://eprints.sunway.edu.my/id/eprint/200

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