Jackknifing Bond Option Prices
AbstractPrices of interest rate derivative securities depend crucially on the mean reversion parameters of the underlying diffusions. These parameters are subject to estimation bias when standard methods are used. The estimation bias can be substantial even in very large samples and much more serious than the discretization bias, and it translates into a bias in pricing bond options and other derivative securities that is important in practical work. This article proposes a very general and computationally inexpensive method of bias reduction that is based on Quenouille's (1956; Biometrika, 43, 353--360) jackknife. We show how the method can be applied directly to the options price itself as well as the coefficients in the models. We investigate its performance in a Monte Carlo study. Empirical applications to U.S. dollar swap rates highlight the differences between bond and option prices implied by the jackknife procedure and those implied by the standard approach. These differences are large and suggest that bias reduction in pricing options is important in practical applications. Copyright 2005, Oxford University Press.
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Bibliographic InfoArticle provided by Society for Financial Studies in its journal The Review of Financial Studies.
Volume (Year): 18 (2005)
Issue (Month): 2 ()
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Other versions of this item:
- Peter C.B. Phillips & Jun Yu, 2003. "Jackknifing Bond Option Prices," Cowles Foundation Discussion Papers 1392, Cowles Foundation for Research in Economics, Yale University.
- Jun Yu & Peter Phillips, 2004. "Jackknifing Bond Option Prices," Econometric Society 2004 North American Winter Meetings 115, Econometric Society.
- C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
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