Path dependent options on yields in the affine term structure model (Q1265769): Difference between revisions

The authors consider path dependent options on yields with fixed time to maturity. Uncertainty is modelled by a single factor Feller-type diffusion for the short rate such that the yields with fixed time to maturity are given by an affine function of the short rate. The choice of this affine term structure model allows the authors to reduce the problem of pricing options on yields to the calculation of expected values for analogous options on the short rate. Pricing formulas for Asian options, a call on maximum, and a lookback call are provided in terms of the Laplace transform of the arithmetic average, and of the family of first hitting times for the short rate. The authors show how to represent the latter via Kummer functions. Thus, in order to calculate prices explicitly, it remains to carry out the inversion of the given Laplace transforms. A brief discussion of the numerical aspects of this problem closes the paper.