Convergence of discrete time option pricing models under stochastic interest rates (Q1979079)

The authors investigate convergence of discrete time pricing models to continuous time models. The markets may be either complete or incomplete and are made of a financial asset and a money market account. The money market account is obtained from a money unit invested at the initial date and rolled over at the successive instantaneous interest rates. Its price is used as discount factor. The continuous dynamics of the asset price and the instantaneous interest rate are characterized under the historical probability by diffusion processes driven by a multidimensional Brownian motion. The authors analyze the joint convergence of sequences of discounted stock prices and Radon-Nikodým derivatives of the minimal martingale measure when interest rates are stochastic. Therefrom they deduce the convergence of option values in either complete or incomplete markets. The general result is illustrated by two main examples: 1) a discrete time i.i.d. approximation of a Merton type pricing model for options on stocks; 2) the trinomial tree of Hull and White for interest rate derivatives.