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Article

Pricing Coupon Bond Options and Swaptions under the One-Factor Hull–White Model

Vincenzo Russo and Frank J. Fabozzi
The Journal of Fixed Income Spring 2016, 25 (4) 76-82; DOI: https://doi.org/10.3905/jfi.2016.25.4.076
Vincenzo Russo
is head of unit—group risk management at Assicurazioni Generali S.p.A. in Milan, Italy.
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  • For correspondence: russovincent@gmail.com
Frank J. Fabozzi
is a professor of finance at EDHEC Business School in Nice, France.
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  • For correspondence: frank.fabozzi@edhec.edu
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Abstract

In this article, the authors propose an alternative approach for pricing bond options and swaptions under the one-factor Hull–White model. Their proposal differs from the existing models used to evaluate these type of instruments when the evolution of the term structure of interest rates is modeled by short-rate models. Assuming that the forward price of a coupon bond is a martingale under the forward risk-neutral measure, the proposed model involves deriving the volatility of the coupon bond as a function of its stochastic duration. Once the volatility function is defined, the price of options on coupon bonds can be derived by simply applying the standard no-arbitrage pricing theory in the context of the one-factor Hull–White model. Given the equivalence between the price of a coupon bond and the price of the corresponding swaptions, this approach can be adopted to calibrate the parameters of the one-factor Hull–White model using swaptions quoted in the market. The new solution proposed for the calibration can be considered as an alternative with respect to the existing approaches proposed in the literature and used currently by practitioners. Numerical results are provided in order to analyze the features of the proposed model for calibration purposes.

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The Journal of Fixed Income: 25 (4)
The Journal of Fixed Income
Vol. 25, Issue 4
Spring 2016
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Pricing Coupon Bond Options and Swaptions under the One-Factor Hull–White Model
Vincenzo Russo, Frank J. Fabozzi
The Journal of Fixed Income Mar 2016, 25 (4) 76-82; DOI: 10.3905/jfi.2016.25.4.076

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Pricing Coupon Bond Options and Swaptions under the One-Factor Hull–White Model
Vincenzo Russo, Frank J. Fabozzi
The Journal of Fixed Income Mar 2016, 25 (4) 76-82; DOI: 10.3905/jfi.2016.25.4.076
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  • Article
    • Abstract
    • THE FRAMEWORK
    • THE PROPOSED MODEL
    • HULL–WHITE MODEL CALIBRATION
    • NUMERICAL RESULTS
    • CONCLUSION
    • ENDNOTES
    • REFERENCES
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