Why Interest Rate Option Model Can Smile?

• Main Authors: Chen, Chi-Chou, 陳麒州
• Other Authors: Kuo, I-Doun
• Format: Others
• Language: en_US
• Published: 2009
• Online Access: http://ndltd.ncl.edu.tw/handle/68909461565420131960

碩士 === 東海大學 === 財務金融學系 === 97 === Past literature explain the presence of volatility smile in interest rate options markets as the consequence of the violation of standard Brownian motion in Heath, Jarrow, and Morton model (HJM, 1992) and proposing alternative approaches to deal this violation is unsatisfactory and insufficient. In this paper, we do not use alternative model to deal with volatility smile, we construct several neutral portfolios by buying the option at the bottom of HJM volatility smile and sell the options on the top of the smile. The trading profits earned in our portfolios indicate volatility smile in Euribor options markets from January 1 2003 to December 31 2005 is not wholly due to the specification error for HJM model. The actual volatility smile pattern in Euribor options markets is steeper than the model predicted in the sample period, particularly for short-term options. We have found that the net buying pressure of Bollen and Whaley (2004) has caused the rise in out-of-the-money calls and puts in Euribor options markets within our examined period.