An Equilibrium Debt Option Pricing Model in Discrete Time

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In this paper we develop a discrete time binomial model for pricing options on default free debt securities. The model is a single factor or spot rate model in which an arbitrage free term structure is developed and used to price any interest rate contingent claim. The model differs from other work in this area in that the model is straightforward to program and use, and is not bound by a restrictive equilibrium concept such as the expectations hypothesis. The paper demonstrates various properties of the model and demonstrates how information from the existing term structure can be used to parameterize the model.