Extracting Probabilistic Information from the Prices of Interest Rate Options: Tests of Distributional Assumptions

Kabir K. Dutta and David Babbel ()
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Kabir K. Dutta: Federal Reserve Bank of Boston

Journal of Business, 2005, vol. 78, issue 3, pages 841-870

Abstract: Return distributions in general and interest rates in particular have been observed to exhibit skewness and kurtosis that cannot be explained by the (log)normal distribution. Using g-and-h distribution we derived a closed-form option pricing formula for pricing European options. We measured its performance using interest rate cap data and compared it with the option prices based on the lognormal, Burr-3, Weibull, and GB2 distributions. We observed that the g-and-h distribution exhibited a high degree of accuracy in pricing options, much better than those other distributions in extracting probabilistic information from the option market.

Date: 2005
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Working Paper: Extracting Probabilistic Information from the Prices of Interest Rate Options: Tests of Distributional Assumptions (2002)
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