@article {Jin67, author = {Hui Jin and Jun-Ya Gotoh and Ushio Sumita}, title = {A New Approach for Computing Option Prices of the Hull-White Type with Stepwise Reversion and Volatility Functions}, volume = {15}, number = {1}, pages = {67--85}, year = {2007}, doi = {10.3905/jod.2007.694793}, publisher = {Institutional Investor Journals Umbrella}, abstract = {Interest rate models, starting with Vasicek, generally include mean-reversion toward a long term level. As such models were applied in the real world to price interest-dependent instruments, including derivatives, they were extended in order to match observed market prices. One way is to introduce more stochastic factors, but the other is to introduce mean-reversion and other kinds of nonstochastic time variation for important parameters, notably volatility. Incorporating such flexibility into a single stochastic factor interest rate lattice requires some method of discretizing these functions, and it is not always easy. In this article, Jin, Gotoh and Sumita develop a new technique involving the use of Ehrenfest functions to approximate mean-reverting O-U processes. Performance of their approach is comparable to a trinomial tree, but it has the advantage of being operational for parameter values for which a trinomial breaks down. It may also facilitate pricing of more complex instruments, with barriers and other such features.TOPICS: Derivatives, statistical methods, technical analysis}, issn = {1074-1240}, URL = {https://jod.pm-research.com/content/15/1/67}, eprint = {https://jod.pm-research.com/content/15/1/67.full.pdf}, journal = {The Journal of Derivatives} }