Option Pricing with Finite Difference Using a Pull-to-Par Bond Model

This article presents a finite difference approach to a pull-to-par model for call and put options on zero-coupon bonds. The original solution was asymptotic and for European-styled options on bonds without coupons. As the asymptotic solution is an approximation to the true solution, the finite difference approach provides an easy alternative to estimating the true value. In addition, the finite difference approach presented here easily allows for the addition of coupons and American style pricing. The authors provide error rates vs. the original solution and illustrate values for options on bonds with coupons.