An Empirical Comparison of Forward‐Rate and Spot‐Rate Models for Valuing Interest‐Rate Options

Bühler, Wolfgang; Uhrig‐Homburg, Marliese; Walter, Ulrich; Weber, Thomas A.

doi:10.1111/0022-1082.00104

Cited by 83 publications

(82 citation statements)

References 34 publications

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“…As already suggested by Heath et al (1992) this can be pushed even further to calibrate the model to a set of yield curve data. Several approaches have been proposed, see for instance Bühler et al (1999) and Driessen at al. (2003).…”

Section: Factors and Volatilitiesmentioning

confidence: 99%

“…Another possibility is to interpolate the term structure with a smooth curve and then differentiate to recover the instantaneous forward rate. This approach, used also by Bühler et al (1999) and by Driessen et al (2003) has the drawback of introducing spurious data. Instead, we let…”

Section: Factors and Volatilitiesmentioning

confidence: 99%

“…A Principal Component Analysis (PCA) is applied on the time series of interest rate yields similarly to Bühler et al (1999) and Driessen et al (2003), among others. Since the approach proposed here is cross-sectional, the PCA is performed only to get an insight on the number of factors and on the shape of the volatility functions and not as a calibration tool.…”

Section: Introductionmentioning

confidence: 99%

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Consistent calibration of HJM models to cap implied volatilities

Angelini

Herzel

2005

J. Fut. Mark.

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This paper proposes a calibration algorithm that fits multi-factor Gaussian models to the implied volatilities of caps using the respective minimal consistent family to infer the forward rate curve. The algorithm is applied to three forward rate volatility structures and their combination to form two-factor models. The efficiency of the consistent calibration is evaluated through comparisons with non-consistent methods. The selection of the number of factors and of the volatility functions is supported by a Principal Component Analysis. Models are evaluated in terms of in-sample and out-of-sample data fitting as well as stability of parameter estimates. The results are analyzed mainly focusing on the capability of fitting the market implied volatility curve and, in particular, of reproducing its characteristic humped shape.

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Section: Factors and Volatilitiesmentioning

confidence: 99%

Section: Factors and Volatilitiesmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

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Consistent calibration of HJM models to cap implied volatilities

Angelini

Herzel

2005

J. Fut. Mark.

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“…14 Bühler, Uhrig, Walter and Weber (1999) test one-and two-factor models in the German fixed-income warrants market, and report that the one-factor forward rate model with linear proportional volatility outperforms all other models. However, their study is 13 A similar model has also been proposed by Miltersen, Sandmann and Sondermann (1997).…”

Section: Empirical Studiesmentioning

confidence: 99%

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

Gupta

Subrahmanyam

2005

Journal of Banking & Finance

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for valuable comments on earlier drafts. We acknowledge with thanks the insightful comments provided by two anonymous referees on a previous draft of the paper, which led to a substantial improvement in our model specifications. We are also thankful to the participants in the seminars at Baruch College, Case Western Reserve University, McGill University, New York University, Rutgers University, University of South Carolina, University of Strathclyde, University of Toronto, and conference participants at the Derivatives Securities Conference at Boston University, the Western Finance Association meetings, the European Financial Management Association meetings, the European Finance Association meetings and the Financial Management Association meetings for comments and suggestions. The usual disclaimer applies. Pricing and Hedging Interest Rate Options:Evidence from Cap-Floor Markets AbstractWe examine the pricing and hedging performance of interest rate option pricing models using daily data on U.S. dollar cap and floor prices across both strike rates and maturities. Our results show that fitting the skew of the underlying interest rate probability distribution provides accurate pricing results within a one-factor framework. However, for hedging performance, introducing a second stochastic factor is more important than fitting the skew of the underlying distribution. This constitutes evidence against claims in the literature that correctly specified and calibrated one-factor models could replace multi-factor models for consistent pricing and hedging of interest rate contingent claims.

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“…The model under certainty is then generalized to become a model under interest rate risk. This step is appropriate in light of the fact that interest rate volatilities have increased in recent years, which has also manifested itself in the growing number of interest rate derivatives and the increased attention to interest rate risk in the relevant literature (e.g., see Heath/Jarrow/Morton (1990), Bühler et al (1999) or Frühwirth (2001). In particular, the influence of term structure and interest rate risk on management decisions has been the subject of increased analysis (e.g., see Ingersoll/Ross (1992) or Höger (1995)).…”

Section: Introductionmentioning

confidence: 99%

The Optimal Timing of the Transfer of Hidden Reserves in the German and Austrian Tax Systems - A Market-Based Approach with Special Attention to the Term Structure of Interest Rates and Interest Rate Risk

Frühwirth

2001

SSRN Journal

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In this paper, the optimal timing of hidden reserves transfers is derived with special attention to the term structure of interest rates and interest rate risk, and using wellknown concepts from the field of finance. The paper presents one model under certainty and, as a generalization of this model, another model under interest rate risk. In both models, the criterion used for decision-making is the value of the right to transfer, which can be interpreted as the initial cost of a replicating/hedging strategy for tax payments incurred/saved. In the model under certainty, the net present value concept is used to derive the value of the right to transfer. The procedure used in the model under interest rate risk is a combination of flexible planning and the no-arbitrage approach common in derivatives pricing. It is shown that the right to transfer hidden reserves with flexible timing is equivalent to an American-style conversion option. In addition, the impact of term-structure volatility on the value of the right to transfer is analyzed. The technique presented in this paper can also be used to solve other timing problems resulting from trade-offs between early and late tax payments/tax benefits.

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An Empirical Comparison of Forward‐Rate and Spot‐Rate Models for Valuing Interest‐Rate Options

Cited by 83 publications

References 34 publications

Consistent calibration of HJM models to cap implied volatilities

Consistent calibration of HJM models to cap implied volatilities

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

The Optimal Timing of the Transfer of Hidden Reserves in the German and Austrian Tax Systems - A Market-Based Approach with Special Attention to the Term Structure of Interest Rates and Interest Rate Risk

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