How to price Target Redemption Notes Using Trees

sushilp · June 9th, 2009, 10:59 am

HiI want to price target redemption note using tree methods. The product is a Dual Currency Deposit (DCD) which has payoff = 2*Call - Put. Let's say there are n-number of fixings (where we calculate the payoff) and maximum payoff of max_P.If sum of all the payoffs (from fixings) reaches maximum payoff the instrument knocks out.

mj · June 9th, 2009, 11:14 pm

auxiliary variable method

sushilp · June 10th, 2009, 7:30 am

thanks mjcould you please give me some reference material?

gjk77 · June 10th, 2009, 3:54 pm

Z. Hu, "Cutting edges using domain integration", Risk, (Nov) 2006 has some mention of TARN's on trees.

sushilp · June 11th, 2009, 4:58 am

thanks gjk..... internet seems to be deprived of Sali-Tree methodologies....

sushilp · June 18th, 2009, 7:46 am

The main problem in pricing Target Redemption Forwards (FX-TARF) using tree method is to apply target condition. We have used Monte Carlo for TARF pricing that gives reasonable result but it works for constant volatility only. To apply volatility smile effectively we are thinking about using Trees.... but how to apply target condition?

LocalVolatility · June 25th, 2009, 9:33 pm

Why should MC be restricted to constant volatility only? You could easily adapt it to work with stochastic volatility models. The main challenge here will be to find a reasonable simulation / discretization scheme for the particular model you are looking at. But there are quite some papers out there concerning this problem for the popular models such as Heston..