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A Valuation Model for the Variable Rate Demand Obligation
School of Economics and Management, Xiamen University Malaysia, Kuala Lumpur, Malaysia
University of Plymouth, Plymouth, UK
- 1 School of Economics and Management, Xiamen University Malaysia, Kuala Lumpur, Malaysia
- 2 University of Plymouth, Plymouth, UK
Journal of Mathematical Finance·Volume 09 (2019)·Pages 388–393·Published 19 June 2019·DOI10.4236/jmf.2019.93022
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Abstract
In this paper, a valuation framework is developed for the variable rate demand obligation (VRDO). The VRDO is a class of floating rate note whose coupon rate changes on a regular basis and is “puttable” by the bondholder, given a notice of one week to the issuer. We model the coupon rate as a geometric Brownian motion process and assume that the incidence of puts is Poisson distributed, across time. Put events are assumed to be brought about by factors such as a change in the liquidity and consumption preferences of investors or a change in a Municipal issuer’s creditworthiness. This paper is unique because as of July 2019 there exists no attempt at valuing VRDOs in the research literature.
KeywordsVariable Rate Demand ObligationMunicipal CorporationPublic PolicyStochastic Calculus
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