PRICING INTEREST RATE DERIVATIVES UNDER MONETARY CHANGES

Alan de Genaro () and Marco Avellaneda ()
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Alan de Genaro: Getulio Vargas Foundation — FGV/EAESP, Brazil
Marco Avellaneda: Courant Institute of Mathematical Sciences — NYU, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2018, vol. 21, issue 06, 1-28

Abstract: The goal of this paper is to develop a reduced-form model for pricing derivatives on the overnight rate. The model incorporates jumps around central bank (CB) meetings. More specifically, rate changes are decomposed into fluctuations between CB meetings and deterministic timed jumps following CB meetings. This approach is useful for practitioners, since it allows the extraction of expectations regarding central bank decisions embedded in liquid instruments, as well as the use of these expectations for the pricing of less liquid derivatives, such as options, in a consistent manner. We discuss applications to 30-Day Fed funds options and IDI options traded in Brazil.

Keywords: Overnight interest rate; deterministic timed jumps; interest rate derivatives (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (3)

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DOI: 10.1142/S0219024918500371

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