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Time-Dependent Variance and the Pricing of Bond Options
Stephen M. Schaefer and Eduardo S. Schwartz
The Journal of Finance
Vol. 42, No. 5 (Dec., 1987), pp. 1113-1128
Stable URL: http://www.jstor.org/stable/2328517
Page Count: 16
You can always find the topics here!Topics: Prices, Standard deviation, Financial instruments, Parametric models, Call options, Financial bonds, Consols, Coupon bonds, Bond principal, Interest rates
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In this paper, we develop a model for valuing debt options that takes into account the changing characteristics of the underlying bond by assuming that the standard deviation of return is proportional to the bond's duration. The resulting model uses the bond price as the single state variable and thus preserves much of the simplicity and robustness of the Black-Scholes approach. The paper provides comparisons between option prices computed using this model and those using the Black-Scholes and Brennan and Schwartz models.
The Journal of Finance © 1987 American Finance Association