Average Interest Rate Caps

Posted: 3 May 1998

See all articles by Terry H. F. Cheuk

Terry H. F. Cheuk

The University of Hong Kong - School of Business

Ton Vorst

VU University Amsterdam - Department of Finance and Financial Sector Management; Tinbergen Institute

Date Written: June 1996

Abstract

There exist a number of approximation methods for the price of average rate options, when the underlying asset is a currency or equity. Realistic pricing models for average interest rate caps based on interbank offered rates have not yet been published. In this paper, we propose to adapt the methods of Levy (1992), Vorst (1992) and Rogers and Shi (1995) for average rate options to price average interest rate caps and compare their computational efficiencies. All three methods are very fast, compared to the Monte Carlo simulation. Two of them are fast enough for on-the-fly calculations. The underlying interest rate model we use is consistent with the observed term structure of interest rate. Hence, the models developed here are suitable for practical implementation.

JEL Classification: G13

Suggested Citation

Cheuk, Terry H. F. and Vorst, Ton A.C.F., Average Interest Rate Caps (June 1996 ). Available at SSRN: https://ssrn.com/abstract=7634

Terry H. F. Cheuk (Contact Author)

The University of Hong Kong - School of Business ( email )

Pokfulam Road
Hong Kong
Hong Kong

Ton A.C.F. Vorst

VU University Amsterdam - Department of Finance and Financial Sector Management ( email )

De Boelelaan 1105
NL-1081HV Amsterdam
Netherlands

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

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