An Optimal Selection of the basis Functions for the Valuation of Interest Rate Structured Notes

Hanki Seong (Hanyang University)
Sang Bin Lee (Hanyang University)

Journal of Derivatives and Quantitative Studies: 선물연구

ISSN: 1229-988X

Article publication date: 30 November 2014

Abstract

We choose the callable bond and the callable range accrual note to show which basis functions are reliable to reduce the estimation errors. For this purpose, we replicate the callable range accrual note with a portfolio of a fixed rate bond and a delayed digital option. We use several basis functions such as a constant, the instantaneous interest rates, and the range in order to see which basis function is efficient for our purpose. We examine several combinations of the basis functions depending on which basis functions will be used for the underlying asset or the continuation value estimation. We show that the range which is an important determinant of the callable range accrual note is an effective basis function to accurately determine the underlying asset and the continuation value for the pricing of the callable range accrual note.

Keywords

Citation

Seong, H. and Lee, S.B. (2014), "An Optimal Selection of the basis Functions for the Valuation of Interest Rate Structured Notes", Journal of Derivatives and Quantitative Studies: 선물연구, Vol. 22 No. 4, pp. 637-674. https://doi.org/10.1108/JDQS-04-2014-B0003

Publisher

:

Emerald Publishing Limited

Copyright © 2014 Emerald Publishing Limited

License

This article is published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this licence may be seen at http://creativecommons.org/licences/by/4.0/legalcode