Interest rate convexity and the volatility smile
When pricing the convexity effect in irregular interest rate derivatives such as, e.g., Libor-in-arrears or CMS, one often ignores the volatility smile, which is quite pronounced in the interest rate options market. This note solves the problem of convexity by replicating the irregular interest flow or option with liquidly traded options with different strikes thereby taking into account the volatility smile. This idea is known among practitioners for pricing CMS caps. We approach the problem on a more general scale and apply the result to various examples.
|Date of creation:||2006|
|Contact details of provider:|| Postal: Sonnemannstraße 9-11, 60314 Frankfurt am Main|
Phone: 069 154008-0
Web page: http://www.frankfurt-school.de/content/en/cpqf
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Ansgar Belke & Thorsten Polleit, 2006.
"How the ECB and the US Fed Set Interest Rates,"
Diskussionspapiere aus dem Institut für Volkswirtschaftslehre der Universität Hohenheim
269/2006, Department of Economics, University of Hohenheim, Germany.
When requesting a correction, please mention this item's handle: RePEc:zbw:cpqfwp:4. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (ZBW - German National Library of Economics)
If references are entirely missing, you can add them using this form.