VALUING EARLY-EXERCISE INTEREST-RATE OPTIONS WITH MULTI-FACTOR AFFINE MODELS

Multi-factor interest-rate models are widely used. Contingent claims with early exercise features are often valued by resorting to trees, finite-difference schemes and Monte Carlo simulations. When jumps are present, however, these methods are less effective. In this work we develop an algorithm based on a sequence of measure changes coupled with Fourier transform solutions of the pricing partial integro-differential equation to solve the pricing problem. The new algorithm, which we call the irFST method, also neatly computes option sensitivities. Furthermore, we are also able to obtain closed-form formulae for accrual swaps and accrual range notes. We demonstrate the versatility and precision of the method through numerical experiments on European, Bermudan and callable bond options, accrual swaps and accrual range notes.