Author: [url=]
Nawdha Thakoor[/url]
Computational Science and Its Applications ¨C ICCSA 2023: 23rd International Conference, Athens, Greece, July 3¨C6, 2023, Proceedings, Part IJul 2023Pages 139¨C151https://doi.org/10.1007/978-3-031-36805-9_10
Abstract
Modelling the term structure of interest rate is of crucial importance nowadays since during times of financial crisis, governments tend to adopt monetary policies which usually result in changes in interest rates. Therefore, it is more realistic to assume that interest rates fluctuate, even over a short time period. Numerous models have been proposed in financial engineering, to describe the stochastic dynamics of interest rates. Interest rate options are among the most liquid options that trade in derivative markets. Due to the enormous size of these markets, there is a need to develop fast and accurate numerical methods for pricing these financial derivatives. In comparison to equity derivatives where a lot of research efforts have been devoted to developing sophisticated methods, research in the area of numerical valuation of interest rate options has been quite sparse. In this paper, we propose a compact localised radial basis function method for pricing interest rate derivatives when exact solutions are not available, as in the case of European and American options on bonds. It is shown numerically that fourth-order accurate results are obtained for American bond options and the proposed method does not suffer from mispricing for long maturity problems or when the short-term rate is high.
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