Fast and Accurate Approximation of Bond Prices When Short Rates are Log-Normal

Journal of Computational Finance, Vol. 3, No. 3, pp. 27-45, 2000

Posted: 21 Dec 2012

See all articles by Asbjorn T. Hansen

Asbjorn T. Hansen

Dresdner Kleinwort Benson; Aarhus University

Peter Løchte Jørgensen

University of Aarhus - Business and Social Sciences

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Date Written: December 20, 2012

Abstract

The authors present an analytical approximation formula for zero-coupon bond prices in a one-factor term structure model where the short interest rate follows a lognormal diffusion. An analytical bound on the error is also derived and is used to show that the pricing formula is virtually exact for a wide range of parameter values. The pricing formula is easily implemented and is extremely fast. Illustrative numerical examples are provided and comparisons with results from implementation of the standard binomial model are made. These comparisons support the effectiveness of the proposed algorithm.

Suggested Citation

Hansen, Asbjorn T. and Jørgensen, Peter Løchte, Fast and Accurate Approximation of Bond Prices When Short Rates are Log-Normal (December 20, 2012). Journal of Computational Finance, Vol. 3, No. 3, pp. 27-45, 2000, Available at SSRN: https://ssrn.com/abstract=2191970

Asbjorn T. Hansen

Dresdner Kleinwort Benson

20 Fenchurch Street
London EC3P 3DB
United Kingdom

Aarhus University ( email )

Dept. of Operations Research
DK-8000 Aarhus C
Denmark

Peter Løchte Jørgensen (Contact Author)

University of Aarhus - Business and Social Sciences ( email )

Finance Research Group
Fuglesangs Allé 4
DK-8210 Aarhus, 8210
Denmark
+4587165117 (Phone)

HOME PAGE: http://pure.au.dk/portal/en/plj@econ.au.dk

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