Pricing of interest rate contingent claims: implementing a simulation approach

Kristian R. Miltersen

Abstract

ABSTRACT

This paper is an empirical study of the Heath-Jarrow-Morton model using time-stamped transactions data of screen-traded Danish bond and option prices. The paper shows how to implement a simulation approach to price contingent claims written on purely interest rate-dependent securities fulfilling the Heath-Jarrow-Morton model. This method implies simulation of solutions of stochastic differential equations since the pricing model is too complicated to give closed-form pricing formulas. Therefore, parameters of the volatility of the Heath-Jarrow-Morton model is estimated using simulated moments estimation. Estimated prices of the model are mostly within the bid-ask spread.