Chapter 7 A discrete time synthesis of derivative security valuation using a term structure of futures prices

Peter Carr, Robert A. Jarrow

Research output: Contribution to journalReview article

Abstract

This paper provided an analytic synthesis of the option pricing literature, using a term structure of futures prices approach. Postulating a process for the evolution of the term structure of futures prices, it is shown how to price derivative secutities in an arbitrage-free manner. Complete markets are assumed. This approach generalizes the traditional methodology by relaxing the assumption of a frictionless spot market (or even the existence of a spot market) and that the underlying commodity is storable. Thus, this method is consistent with short sale constraints in the spot market for the underlying commodity. When short sale restrictions are removed, the traditional option pricing models are shown to be obtainable as special cases. This includes the binomial model of CRR, as well as its applications to index options, currency options and commodity options. The new interest rate options models of HJM are also shown to be a subset of this framework. A brief discussion of how to empirically implement the model is also provided. References are given to reviews of the empirical literature and historic surveys of the model development.

Original languageEnglish (US)
Pages (from-to)225-249
Number of pages25
JournalHandbooks in Operations Research and Management Science
Volume9
Issue numberC
DOIs
StatePublished - 1995

Fingerprint

Derivatives
Sales
Costs
Discrete-time
Term structure
Futures prices
Spot market
Commodities
Derivative securities
Security valuation
Interest rate options
Short-sale constraints
Index options
Option pricing model
Short sales
Arbitrage
Model development
Methodology
Currency options
Option pricing

ASJC Scopus subject areas

  • Computer Science Applications
  • Management Science and Operations Research
  • Economics and Econometrics
  • Finance

Cite this

Chapter 7 A discrete time synthesis of derivative security valuation using a term structure of futures prices. / Carr, Peter; Jarrow, Robert A.

In: Handbooks in Operations Research and Management Science, Vol. 9, No. C, 1995, p. 225-249.

Research output: Contribution to journalReview article

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