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The Journal of Real Estate Finance and Economics

Erschienen in:

03.09.2016

A Lattice Framework with Smooth Convergence for Pricing Real Estate Derivatives with Stochastic Interest Rate

verfasst von: Dong Zou, Pu Gong

Erschienen in: The Journal of Real Estate Finance and Economics | Ausgabe 2/2017

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Abstract

In this paper, a general binomial lattice framework, which is both computationally simple and numerically accurate, is developed for pricing real estate derivatives with stochastic interest rate. To obtain a computationally simple binomial tree with constant volatility, the transformation method and the probability density matching approach are introduced. A tilt parameter is then added to the jump movements to obtain smooth convergence. Therefore, the Richardson extrapolation (RE) can be used to enhance the convergence of the discrete binomial lattice models to continuous models when pricing European options. In addition, our smooth convergent models can also be applied to pricing American options.

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The time-varying volatility is considered by Fabozzi et al. (2012) when the evolution of the volatility is deterministic. They pointed out that the volatility can be also considered as stochastic or following the dynamics of a GARCH process. However, this type of modelling will raise another layer of market incompleteness that will be difficult to resolve considering that real estate derivatives are not highly liquid yet as an asset class.

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Titel: A Lattice Framework with Smooth Convergence for Pricing Real Estate Derivatives with Stochastic Interest Rate
verfasst von: Dong Zou
Pu Gong
Publikationsdatum: 03.09.2016
Verlag: Springer US
Erschienen in: The Journal of Real Estate Finance and Economics / Ausgabe 2/2017
Print ISSN: 0895-5638
Elektronische ISSN: 1573-045X
DOI: https://doi.org/10.1007/s11146-016-9576-x

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