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Evaluation of Callable Bonds: Finite Difference Methods, Stability and Accuracy

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  • Buttler, Hans-Jurg

Abstract

The purpose of this paper is to evaluate numerically the semi-American callable bond by means of finite difference methods. This study implies three results. First, the numerical error is greater for the callable bond price than for the straight bond price, and too large for real applications Secondly, the numerical accuracy of the callable bond price computed for the relevant range of interest rates depends entirely on the finite difference scheme which is chosen for the boundary points. Thirdly, the boundary scheme which yields the smallest numerical error with respect to the straight bond does not perform best with respect to the callable bond. Copyright 1995 by Royal Economic Society.

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  • Buttler, Hans-Jurg, 1995. "Evaluation of Callable Bonds: Finite Difference Methods, Stability and Accuracy," Economic Journal, Royal Economic Society, vol. 105(429), pages 374-384, March.
    • Handle: RePEc:ecj:econjl:v:105:y:1995:i:429:p:374-84
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    Cited by:

    1. Dongjae Lim & Lingfei Li & Vadim Linetsky, 2012. "Evaluating Callable and Putable Bonds: An Eigenfunction Expansion Approach," Papers 1206.5046, arXiv.org.
    2. Peter D Spencer, "undated". "Coupon Bond Valuation with a Non-Affine Discount Yield Model," Discussion Papers 03/16, Department of Economics, University of York.
    3. Dejun Xie, 2009. "Theoretical And Numerical Valuation Of Callable Bonds," The International Journal of Business and Finance Research, The Institute for Business and Finance Research, vol. 3(2), pages 71-82.
    4. Posch, Olaf & Trimborn, Timo, 2013. "Numerical solution of dynamic equilibrium models under Poisson uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 37(12), pages 2602-2622.
    5. Barone-Adesi, Giovanni & Bermudez, Ana & Hatgioannides, John, 2003. "Two-factor convertible bonds valuation using the method of characteristics/finite elements," Journal of Economic Dynamics and Control, Elsevier, vol. 27(10), pages 1801-1831, August.

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