In light of the fact that no existing tree algorithms can guarantee the recombination property for general Ornstein-Uhlenbeck processes with time-dependent parameters, a new trinomial recombination-tree algorithm is designed in this research. The proposed algorithm enhances the existing mechanisms in interest-rate modelings with the comparisons to [1,2] methodologies, and the proposed framework provides a more efficient way in discrete-time mean-reverting simulations.
References
[1]
J. Hull and A. White, “Pricing Interest-Rate-Derivative Securities,” Review of Financial Studies, Vol. 3, No. 4, 1990, pp. 573-592. http://dx.doi.org/10.1093/rfs/3.4.573
[2]
F. Black, E. Derman and W. Toy, “A One-Factor Model of Interest Rates and Its Application to Treasury Bond Options,” Financial Analysts Journal, Vol. 46, No. 1, 1990, pp. 33-39. http://dx.doi.org/10.2469/faj.v46.n1.33
[3]
T. H. Cormen, C. E. Leiserson, R. L. Rivest and C. Stein, “Introduction to Algorithms,” 3rd Edition, The MIT Press, Cambridge, 2009.
[4]
J. Hull, “Options, Futures, and Other Derivatives,” 7th Edition, Prentice Hall, Upper Saddle River, 2008.
[5]
D. Brigo and F. Mercurio, “Interest Rate Models-Theory and Practice,” 2nd Edition, Springer, New York, 2006.
