Modelling Callable Annuity Bonds with Interest-Only Optionality

Anders Holst, Morten Nalholm

Research output: Working paperResearch

Abstract

In this paper an investigation of the pricing of callable annuities with interest-only(I-O) optionality is conducted. First the I-O optionality feature of callable annuities isintroduced. Next an algorithm for pricing callable annuities with I-O optionality usingthe finite difference methodology, is formulated. This is then used to investigate optimalstrategies of I-O bonds and impacts on prices from the I-O optionality. It is found thatthe I-O feature necessitates a simultaneous valuation of all elements of the callable I-Obond. Following this, the Greeks of the I-O bond are investigated. It is found that they are affected by the I-O feature, but only to a limited extent. Finally, a model of heterogenousprepayment decisions is incorporated into the framework. The model is extended to modelheterogeneity in the I-O exercise decisions. The incorporation of heterogeneity in borrowerdecisions is found to lead to reasonable causalities.
Original languageEnglish
Place of PublicationKøbenhavn
PublisherCopenhagen Business School [wp]
Number of pages47
ISBN (Print)8790705823
Publication statusPublished - 2004

Cite this

Holst, A., & Nalholm, M. (2004). Modelling Callable Annuity Bonds with Interest-Only Optionality. København: Copenhagen Business School [wp].
Holst, Anders ; Nalholm, Morten . / Modelling Callable Annuity Bonds with Interest-Only Optionality. København : Copenhagen Business School [wp], 2004.
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Holst, A & Nalholm, M 2004 'Modelling Callable Annuity Bonds with Interest-Only Optionality' Copenhagen Business School [wp], København.

Modelling Callable Annuity Bonds with Interest-Only Optionality. / Holst, Anders; Nalholm, Morten .

København : Copenhagen Business School [wp], 2004.

Research output: Working paperResearch

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Holst A, Nalholm M. Modelling Callable Annuity Bonds with Interest-Only Optionality. København: Copenhagen Business School [wp]. 2004.