Skip navigation

The economic determinants of interest rate option smiles

Authors: Deuskar, PRACHI
Issue Date: 18-May-2007
Series/Report no.: FIN-07-016
Abstract: We address three questions relating to the interest rate options market: What is the shape of the smile? What are the economic determinants of the shape of the smile? Do these determinants have predictive power for the future shape of the smile and vice versa? We investigate these issues using daily bid and ask prices of euro (€) interest rate caps/floors. We find a clear smile pattern in interest rate options. The shape of the smile varies over time and is affected in a dynamic manner by yield curve variables and the future uncertainty in the interest rate markets; it also has information about future aggregate default risk. Our findings are useful for the pricing, hedging and risk management of these derivatives.
Appears in Collections:Finance Working Papers

Files in This Item:
File Description SizeFormat 
07-16.pdf973.14 kBAdobe PDFView/Open

Items in FDA are protected by copyright, with all rights reserved, unless otherwise indicated.