Why Do Interest Rate Options Smile?

Deuskar, P and Gupta, A and Subrahmanyam, M G (2006) Why Do Interest Rate Options Smile? Working Paper. SSRN. (Unpublished)

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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 futures 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 Creiators:
ISB Creators
ORCiD
Deuskar, P
UNSPECIFIED
Item Type: Monograph (Working Paper)
Uncontrolled Keywords: Interest rate, Economic determinants, Risk management
Subjects: Finance
Depositing User: Ilayaraja M
Date Deposited: 19 May 2019 14:44
Last Modified: 19 May 2019 14:44
URI: http://eprints.exchange.isb.edu/id/eprint/1021
Publisher URL: https://ssrn.com/abstract=1293656
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