THE VALUATION OF AMERICAN OPTIONS WITH STOCHASTIC INTEREST-RATES - A GENERALIZATION OF THE GESKE-JOHNSON TECHNIQUE

The Geske-Johnson approach provides an efficient and intuitively appea ling technique for the valuation and hedging of American-style conting ent claims. Here, we generalize their approach to a stochastic interes t rate economy. The method is implemented using options exercisable on one of a finite number of dates. We illustrate how the value of an Am erican-style option increases with interest rate volatility. The magni tude of this effect depends on the extent to which the option is in th e money, the volatilities of the underlying asset and the interest rat es, as well as the correlation between them.