Pricing LYONs under Stochastic Interest Rates

Abstract

In this study, one of the simplifying assumptions of the McConnell and Schwartz (1986) LYON pricing model is relaxed. We present a valuation model that incorporates stochastic interest rates. LYON prices are computed with the modified explicit finite differences method of Hull and White (1990) and with the Least-Squares Monte Carlo technique. For the Waste Management issue, we find that the value of the LYON is very sensitive to the market price of interest rate risk and somehow sensitive to the correlation coefficient between interest rates and stock returns.