Abstract
ABSTRACTThis paper presents a general framework for pricing contingent claims under interest rate and asset price uncertainty. The framework extends Ho and Lee's (1986) valuation framework by allowing not only future interest rates but also future asset prices to depend on the current term structure of interest rates. The approach is shown to provide risk‐neutral valuation relationships that are consistent with the initial term structure of interest rates and can be applied to valuation of a broad class of assets including stock options, convertible bonds, and junk bonds.
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