Approximate Formulae for Pricing Zero-Coupon Bonds and Their Asymptotic Analysis

Abstract

We analyze analytic approximation formulae for pricing zero-coupon bonds in the case when the short-term interest rate is driven by a one-factor mean-reverting process with a volatility nonlinearly depending on the interest rate itself. We derive the order of accuracy of the analytical approximation due to Choi and Wirjanto. We furthermore give an explicit formula for a higher order approximation and we test both approximations numerically for a class of one-factor interest rate models.