TITLE:
A Valuation Model for the Variable Rate Demand Obligation
AUTHORS:
Vince Hooper, John Pointon
KEYWORDS:
Variable Rate Demand Obligation, Municipal Corporation, Public Policy, Stochastic Calculus
JOURNAL NAME:
Journal of Mathematical Finance,
Vol.9 No.3,
August
21,
2019
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.