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Pricing and hedging interest rate options: Evidence from cap-floor markets

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  • Gupta, Anurag
  • Subrahmanyam, Marti G.

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  • Gupta, Anurag & Subrahmanyam, Marti G., 2005. "Pricing and hedging interest rate options: Evidence from cap-floor markets," Journal of Banking & Finance, Elsevier, vol. 29(3), pages 701-733, March.
  • Handle: RePEc:eee:jbfina:v:29:y:2005:i:3:p:701-733
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    1. Alan Brace & Dariusz G¸atarek & Marek Musiela, 1997. "The Market Model of Interest Rate Dynamics," Mathematical Finance, Wiley Blackwell, vol. 7(2), pages 127-155.
    2. Rong Fan & Anurag Gupta & Peter Ritchken, 2003. "Hedging in the Possible Presence of Unspanned Stochastic Volatility: Evidence from Swaption Markets," Journal of Finance, American Finance Association, vol. 58(5), pages 2219-2248, October.
    3. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    4. Gupta, Anurag & Subrahmanyam, Marti G., 2000. "An empirical examination of the convexity bias in the pricing of interest rate swaps," Journal of Financial Economics, Elsevier, vol. 55(2), pages 239-279, February.
    5. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 627-627, November.
    6. Frank de Jong & Joost Driessen & Antoon Pelsser, 2004. "On the Information in the Interest Rate Term Structure and Option Prices," Review of Derivatives Research, Springer, vol. 7(2), pages 99-127, August.
    7. Peter Ritchken & L. Sankarasubramanian, 1995. "Volatility Structures Of Forward Rates And The Dynamics Of The Term Structure," Mathematical Finance, Wiley Blackwell, vol. 5(1), pages 55-72.
    8. Brennan, Michael J. & Schwartz, Eduardo S., 1979. "A continuous time approach to the pricing of bonds," Journal of Banking & Finance, Elsevier, vol. 3(2), pages 133-155, July.
    9. Driessen, Joost & Klaassen, Pieter & Melenberg, Bertrand, 2003. "The Performance of Multi-Factor Term Structure Models for Pricing and Hedging Caps and Swaptions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(03), pages 635-672, September.
    10. Jagannathan, Ravi & Kaplin, Andrew & Sun, Steve, 2003. "An evaluation of multi-factor CIR models using LIBOR, swap rates, and cap and swaption prices," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 113-146.
    11. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters,in: Theory Of Valuation, chapter 5, pages 129-164 World Scientific Publishing Co. Pte. Ltd..
    12. Buser, Stephen A & Hendershott, Patric H & Sanders, Anthony B, 1990. "Determinants of the Value of Call Options of Default-Free Bonds," The Journal of Business, University of Chicago Press, vol. 63(1), pages 33-50, January.
    13. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-592.
    14. Amin, Kaushik I. & Morton, Andrew J., 1994. "Implied volatility functions in arbitrage-free term structure models," Journal of Financial Economics, Elsevier, vol. 35(2), pages 141-180, April.
    15. Pierre Collin-Dufresne & Robert S. Goldstein, 2002. "Do Bonds Span the Fixed Income Markets? Theory and Evidence for Unspanned Stochastic Volatility," Journal of Finance, American Finance Association, vol. 57(4), pages 1685-1730, August.
    16. Miltersen, Kristian R & Sandmann, Klaus & Sondermann, Dieter, 1997. " Closed Form Solutions for Term Structure Derivatives with Log-Normal Interest Rates," Journal of Finance, American Finance Association, vol. 52(1), pages 409-430, March.
    17. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
    18. Francis A. Longstaff, 2001. "The Relative Valuation of Caps and Swaptions: Theory and Empirical Evidence," Journal of Finance, American Finance Association, vol. 56(6), pages 2067-2109, December.
    19. Michael J. Brennan and Eduardo S. Schwartz., 1979. "A Continuous-Time Approach to the Pricing of Bonds," Research Program in Finance Working Papers 85, University of California at Berkeley.
    20. Ho, Thomas S Y & Lee, Sang-bin, 1986. " Term Structure Movements and Pricing Interest Rate Contingent Claims," Journal of Finance, American Finance Association, vol. 41(5), pages 1011-1029, December.
    21. Massoud Heidari & Liuren WU, 2002. "Are Interest Rate Derivatives Spanned by the Term Structure of Interest Rates?," Finance 0207013, EconWPA.
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    Cited by:

    1. Robert Jarrow & Haitao Li & Feng Zhao, 2007. "Interest Rate Caps "Smile" Too! But Can the LIBOR Market Models Capture the Smile?," Journal of Finance, American Finance Association, vol. 62(1), pages 345-382, February.
    2. Kuo, I-Doun & Lin, Yueh-Neng, 2009. "Empirical performance of multifactor term structure models for pricing and hedging Eurodollar futures options," Review of Financial Economics, Elsevier, vol. 18(1), pages 23-32, January.
    3. Thomas Busch & Bent Jesper Christensen & Morten Ørregaard Nielsen, 2006. "The Information Content of Treasury Bond Options Concerning Future Volatility and Price Jumps," Working Papers 1188, Queen's University, Department of Economics.
    4. I‐Doun Kuo & Kai‐Li Wang, 2009. "Implied deterministic volatility functions: An empirical test for Euribor options," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 29(4), pages 319-347, April.
    5. M. Krivko & M. V. Tretyakov, 2011. "Numerical integration of Heath-Jarrow-Morton model of interest rates," Papers 1109.2557, arXiv.org.
    6. Raoul Pietersz & Antoon Pelsser, 2010. "A comparison of single factor Markov-functional and multi factor market models," Review of Derivatives Research, Springer, vol. 13(3), pages 245-272, October.
    7. Zhiqiang Zhang & Dan A. Ralescu & Weiqi Liu, 2016. "Valuation of interest rate ceiling and floor in uncertain financial market," Fuzzy Optimization and Decision Making, Springer, vol. 15(2), pages 139-154, June.
    8. Sami Attaoui, 2011. "Hedging performance of the Libor market model: the cap market case," Applied Financial Economics, Taylor & Francis Journals, vol. 21(16), pages 1215-1223.
    9. Jury Falini, 2009. "Pricing caps with HJM models: the benefits of humped volatility," Department of Economics University of Siena 563, Department of Economics, University of Siena.
    10. Jaroslav Brada, 2014. "Use of Forward Interest Rates and Forward Exchange Rates for the Valuation of Currency-Interest Rate Derivatives," Český finanční a účetní časopis, University of Economics, Prague, vol. 2014(1).
    11. Roel C.A. Oomen, 2004. "Statistical Models for High Frequency Security Prices," Econometric Society 2004 North American Winter Meetings 77, Econometric Society.
    12. Svenstrup, Mikkel, 2003. "On the Suboptimality of Single-Factor Exercise Strategies for Bermudan Swaptions," Finance Working Papers 02-24, University of Aarhus, Aarhus School of Business, Department of Business Studies.
    13. Cathy Chen & I-Doun Kuo, 2014. "Investor sentiment and interest rate volatility smile: evidence from Eurodollar options markets," Review of Quantitative Finance and Accounting, Springer, vol. 43(2), pages 367-391, August.
    14. Lie-Jane Kao, 2016. "Credit valuation adjustment of cap and floor with counterparty risk: a structural pricing model for vulnerable European options," Review of Derivatives Research, Springer, vol. 19(1), pages 41-64, April.
    15. Chen, Cathy Yi-Hsuan & Kuo, I-Doun, 2015. "Survey sentiment and interest rate option smile," International Review of Economics & Finance, Elsevier, vol. 37(C), pages 125-137.
    16. Antonio Mannolini & Carlo Mari & Roberto Renò, 2008. "Pricing caps and floors with the extended CIR model," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 13(4), pages 386-400.
    17. Robert A. Jarrow, 2009. "The Term Structure of Interest Rates," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 69-96, November.
    18. Falini, Jury, 2010. "Pricing caps with HJM models: The benefits of humped volatility," European Journal of Operational Research, Elsevier, vol. 207(3), pages 1358-1367, December.
    19. Jaroslav Brada, 2014. "Use of Forward Interest Rates and Forward Exchange Rates for the Valuation of Currency-Interest Rate Derivatives," Český finanční a účetní časopis, University of Economics, Prague, vol. 2014(1), pages 6-18.
    20. I.-Doun Kuo, 2011. "Pricing and hedging volatility smile under multifactor interest rate models," Review of Quantitative Finance and Accounting, Springer, vol. 36(1), pages 83-104, January.
    21. Deuskar, Prachi & Gupta, Anurag & Subrahmanyam, Marti G., 2008. "The economic determinants of interest rate option smiles," Journal of Banking & Finance, Elsevier, vol. 32(5), pages 714-728, May.
    22. Haitao Li & Feng Zhao, 2009. "Nonparametric Estimation of State-Price Densities Implicit in Interest Rate Cap Prices," Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4335-4376, November.
    23. Svenstrup, Mikkel, 2005. "On the suboptimality of single-factor exercise strategies for Bermudan swaptions," Journal of Financial Economics, Elsevier, vol. 78(3), pages 651-684, December.

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