Pricing stock options with stochastic interest rate
by Menachem Abudy; Yehuda Izhakian
International Journal of Portfolio Analysis and Management (IJPAM), Vol. 1, No. 3, 2013

Abstract: This paper constructs a closed-form generalisation of the Black-Scholes model for the case where the short-term interest rate follows a stochastic Gaussian process. Capturing this additional source of uncertainty appears to have a considerable effect on option prices. We show that the value of a stock option increases with the volatility of the interest rate and with its time to maturity. The empirical tests support the theoretical model and demonstrate a significant pricing improvement relative to the Black-Scholes model. The magnitude of the improvement is a positive function of the option's time to maturity; the largest improvement being obtained for around-the-money options.

Online publication date: Sat, 05-Jul-2014

The full text of this article is only available to individual subscribers or to users at subscribing institutions.

 
Existing subscribers:
Go to Inderscience Online Journals to access the Full Text of this article.

Pay per view:
If you are not a subscriber and you just want to read the full contents of this article, buy online access here.

Complimentary Subscribers, Editors or Members of the Editorial Board of the International Journal of Portfolio Analysis and Management (IJPAM):
Login with your Inderscience username and password:

Username:        Password:          Forgotten your password?

Want to subscribe?
A subscription gives you complete access to all articles in the current issue, as well as to all articles in the previous three years (where applicable). See our Orders page to subscribe.

If you still need assistance, please email subs@inderscience.com