November 1998
Intermediate to advanced
220 pages
6h 36m
English
Content preview from Fixed Income and Interest Rate Derivative Analysis
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STATE PRICES, FORWARD INDUCTION, AND TREE-FITTING 101
The completed state price tree"
0.455
7
/ \
0.203
1 0.414
\ /
\
0.455
0.212
YearO Year 1 Year2
can now be used to price securities. Consider the bond option which made
payments in year 2 of (0, 0.91, 4.34). Using the state prices at year 2 we can
value this option by
V-0.203 x 0 § 0.414 x 0.91 + 0.212 x 4.34
= $1.29
which is the same valuation as that obtained using
Chapter 5.
backward induction in
6.3
Interest rate trees
The first thing to be decided is the interest rate model that will be used.
Different models ...
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