Abstract
The main feature of switchable bonds is the option of the issuer to flip the fixed–coupon yield to a given floating rate; this right could be exercised only on certain dates during the life of the bond. Given the Bermuda nature of the option, it is not possible to price the switchable bonds using standard simulation techniques.
However, the technique of multinomial trees can be exploited. To preserve consistency with the pricing of vanilla bonds, it is suitable to assume that the short interest rate follows a stochastic process in the arbitrage free framework.
One of the possibilities for modelling the short rate process is the Hull–White model which involves two parameters not directly observable in the market. We have developed a pricing algorithm based on the Hull–White trinomial tree that has the desired properties and calibrated the model parameters to the market data.