A Unified Approximation Formula for Zero-Coupon Bond Prices
11 Pages Posted: 3 Aug 2014
Date Written: July 27, 2014
Abstract
This paper provides an analytical approximation for zero-coupon bond prices when the short rate follows a diffusion process. Unlike previous methods, our method, based on successive substitution proposed by Funahashi and Kijima (2015), is applicable for general short rate models. Through ample numerical examples, we show that the accuracy of our approximation is quite high even in the case of high volatilities and/or long maturities. Comparisons are made with the existing methods in the literature.
Keywords: Short rate model, Successive substitution, Wiener-Ito chaos expansion, Zero-Coupon
JEL Classification: G12, G13
Suggested Citation: Suggested Citation