The economic determinants of interest rate option smiles

Deuskar, P and Gupta, A and Subrahmanyam, M G (2008) The economic determinants of interest rate option smiles. Journal of Banking & Finance, 32 (5). 714 - 728.

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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.

Affiliation: Indian School of Business
ISB Creators:
ISB CreatorsORCiD
Deuskar, PUNSPECIFIED
Item Type: Article
Additional Information: The research paper was published by the author with the affiliation of University of Illinois.
Uncontrolled Keywords: Volatility smiles, Interest rate options, Euro interest rate markets, Euribor market
Subjects: Finance
Depositing User: Ilayaraja M
Date Deposited: 17 May 2019 16:25
Last Modified: 17 May 2019 16:25
URI: http://eprints.exchange.isb.edu/id/eprint/1012
Publisher URL: https://doi.org/10.1016/j.jbankfin.2007.05.012
Publisher OA policy: http://sherpa.ac.uk/romeo/issn/0378-4266/
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