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Reading Interest Rate and Bond Futures Options' Smiles: How PIBOR and National Operators Appreciated the 1997 French Snap Election

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Author Info

  • Coutant, S.
  • Jondeau, E.
  • Rockinger, M.

Abstract

The aim of this paper is to compare various methods which extract a Risk Neutral Density (RND) out of PIBOR as well as of Notional interest rate futures options and to investigate how traders reacted to a political event. We first focus on 5 dates surrounding the 1997 snap election and several methods: Black (1976), a mixture of lognormals (as in Melick and Thomas, 1997), an Hermite expansion (as in Abken, Madan, and Ramamurtie, 1996), and a method based on Maximum Entropy (following Kelly and Buchen, 1996). By and large the various methods give similar RNDs. Yet, the Hermite expansion approach, by allowing for somewhat dirty options prices, by providing a good fit to options prices, and by being very fast is the retained method for the data at hand. We then consider a daily panel of options running from February 1997 to July 1997. After constructing standardized options, i.e. with a fixed time to maturity, we find that operators in both markets anticipated the snap election a few days before the official announcement and that a substantial amount of political uncertainty subsisted even a month after the elections. The greater liquidity of PIBOR options eases information extraction.

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File URL: http://www.banque-france.fr/uploads/tx_bdfdocumentstravail/ner54_02.pdf
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Bibliographic Info

Paper provided by Banque de France in its series Working papers with number 54.

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Length: 28 pages
Date of creation: 1998
Date of revision:
Handle: RePEc:bfr:banfra:54

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Related research

Keywords: Interest rate ; Pricing ; Risk ; Politics;

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Cited by:
  1. Martin Mandler, 2002. "Extracting Market Expectations from Option Prices: Two Case Studies in Market Perceptions of the ECB's Monetary Policy 1999/2000," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 138(II), pages 165-189, June.
  2. de Vincent-Humphreys, Rupert & Puigvert GutiƩrrez, Josep Maria, 2010. "A quantitative mirror on the Euribor market using implied probability density functions," Working Paper Series 1281, European Central Bank.

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