Numerical methods for pricing callable bonds

Abstract

This work demonstrates that it is possible to obtain accurate values of callable bonds using a fully numerical approach, provided that the PDE is discretized appropriately. To facilitate comparisons with results reported by Buttler and Waldvogel (1996), we consider models with a single factor: the instantaneous risk free interest rate. We emphasize, however, that it is straightforward to extend the numerical methods described to cases where the Green's function cannot be determined analytically as well as to cases with time-dependent parameters (typically used to match current term structures of interest rates/interest rate volatilities), or multi-factor interest rate models.