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Valuing Derivative Securities Using the Explicit Finite Difference Method
John Hull and Alan White
The Journal of Financial and Quantitative Analysis
Vol. 25, No. 1 (Mar., 1990), pp. 87-100
Published by: Cambridge University Press on behalf of the University of Washington School of Business Administration
Stable URL: http://www.jstor.org/stable/2330889
Page Count: 14
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This paper suggests a modification to the explicit finite difference method for valuing derivative securities. The modification ensures that, as smaller time intervals are considered, the calculated values of the derivative security converge to the solution of the underlying differential equation. It can be used to value any derivative security dependent on a single state variable and can be extended to deal with many derivative security pricing problems where there are several state variables. The paper illustrates the approach by using it to value bonds and bond options under two different interest rate processes.
The Journal of Financial and Quantitative Analysis © 1990 University of Washington School of Business Administration