Pricing American put option on zero-coupon bond under fractional CIR model with transaction cost

Abstract

ABSTRACTThe motivation of this study is to evaluate the American put option on zero-coupon bond, when the interest rate model is governed by a fractional CIR (FCIR) interest rate model. Since the existence of fractional Brownian motion, leading to create the arbitrage, we employ the transaction cost for eliminating the arbitrage. We first of all apply the Leland's hedging strategy for a self-financing portfolio that contains an American option and zero-coupon bond and derive a formula for the transaction cost. We perform the least-square Monte Carlo (LSM) method for pricing American option under the proposed interest rate model.