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Pricing Asian Interest Rate Options with a Three-Factor HJM Model

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  • Claudio Henrique da Silveira Barbedo
  • José Valentim Machado Vicente
  • Octávio Manuel Bessada Lion

Abstract

Pricing interest rate derivatives is a challenging task that has attracted the attention of many researchers in recent decades. Portfolio and risk managers, policymakers, traders and more generally all market participants are looking for valuable information from derivative instruments. We use a standard procedure to implement the HJM model and to price IDI options. We intend to assess the importance of the principal components of pricing and interest rate hedging derivatives in Brazil, one of the major emerging markets. Our results indicate that the HJM model consistently underprices IDI options traded in the over-the-counter market while it overprices those traded in the exchange studied. We also find a direct relationship between time to maturity and pricing error and a negative relation with moneyness.

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File URL: http://www.bcb.gov.br/pec/wps/ingl/wps188.pdf
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Bibliographic Info

Paper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 188.

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Date of creation: Jun 2009
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Handle: RePEc:bcb:wpaper:188

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Web page: http://www.bcb.gov.br/?english

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