FRANK J. FABOZZI, PH.D., CFA, CPA
Professor of FinanceEDHEC Business School
ANDREW KALOTAY, PH.D.
PresidentAndrew Kalotay Associates
MICHAEL DORIGAN, PH.D.
Director & Senior Quantitative AnalystPNC Capital Advisors LLC
The complication in building a model to value bonds with embedded options and option-type derivatives is that cash flows will depend on interest rates in the future. Academicians and practitioners have attempted to capture this interest rate uncertainty through various models, often designed as single or multi-factor models. These models attempt to capture the stochastic behavior of rates.
In practice, these elegant mathematical models must be converted to numeric applications. ...