Valuing Call Options on Bonds: Replication vs Risk-Neutral
1. Context
In this short video, we explore two methods for valuing call options on bonds. The first method is the replicating portfolio approach, in which we build a portfolio that contains appropriate quantities of traded instruments that mimic the payoff of the option. In the second method, we value the call option using discounted expectations in a risk-neutral world i.e. using risk-neutral probabilities. The details of the reading in which this topic appears are given below:
| Area | Market Risk |
| Reading | The Science of Term Structure Models |
| Reference | Bruce Tuckman and Angel Serrat, Chapter 7. The Science of Term Structure Models In Fixed Income Securities, 3rd Edition, (Hoboken, NJ: John Wiley & Sons, 2011). |