Application of the Heath-Platen Estimator in the Fong-Vasicek Short Rate Model

Abstract

Due to the presence of stochastic volatility dynamics, the Fong-Vasicek short rate model is more complex but also more realistic than the classical Vasicek version. To enhance the numerical tractability of the Fong-Vasicek model for the calculation of bond option prices, we suggest the use of the Heath-Platen estimator which performs excellently in the related Heston stochastic volatility model. We show that the Heath-Platen estimator reduces the variance and thus the size of confidence intervals dramatically compared to a crude Monte Carlo estimation, which leads to a drastic speed-up in price calculations across different realistic parameter sets.