Journal of Risk

Risk.net

Instantaneous caps and floors on the short-rate

Snorre Lindset

ABSTRACT

In this paper we propose new types of caps and floors. The derivatives are written on the instantaneous short rate. The cap (floor) accumulates interest only when the short rate is above the cap rate (below the floor rate). The accumulation factors are the difference between the short rate and the cap rate and the difference between the floor rate and the short rate. The floor can also be used to construct a contract with an instantaneous minimum guaranteed rate of return. We propose a way to approximate the market values of these derivatives. To this end, we use derivatives for which the market values can be easily evaluated in closed form and combine the different values in a given way. Numerical investigations indicate that our approximations give highly reliable price estimates.

Sorry, our subscription options are not loading right now

Please try again later. Get in touch with our customer services team if this issue persists.

New to Risk.net? View our subscription options

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here