Analyzing Short-Rate Models for Efficient Bond Option Pricing: A Review

Short-rate models play an essential part in option pricing by accurately modeling interest rate movements and valuing interest rate derivatives. This review paper provides an in-depth analysis of zero-coupon bond option pricing, with a detailed exploration of the single-factor short-rate models. Starting with a thorough overview of the relevant literature, the study scrutinizes the intricacies of one-factor short-rate models, elucidating their theoretical underpinnings and practical implications within the current research landscape. Various methodological approaches utilized in previous years are examined, highlighting their strengths and limitations. The primary significance of this paper lies in its systematic review of seminal and recent scholarly articles focusing parametric approaches, offering a critical evaluation of methodologies, assumptions, and findings. Moreover, the paper identifies gaps in the current literature and proposes potential areas for future research in the domain.