Efficient valuation of callable bonds: The dynamic Chebyshev method

Kathrin Glau, Christian Pötz, Mikhail Soloveitchik, and Linus Wunderlich

We investigate the application of the dynamic Chebyshev method to the pricing of callable bonds.

Callable corporate bonds belong to the most important fixed income instruments in financial markets. Acknowledging the fact that the academic literature on efficient pricing of these instruments has been less prioritized in the past, we aim to close this gap. In order to put the method under test in a model that is relevant for practice, we consider a two-factor rate/credit model. We formulate the pricing problem as a dynamic programming problem and present a dynamic Chebyshev algorithm for this problem in a simplified setting. Finally, we present some numerical results.

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