 Empirical performance of multifactor term structure models for pricing and hedging Eurodollar futures optionsI-Doun Kuo and Yueh-Neng Lin Review of Financial Economics, 2009, vol. 18, issue 1, 23-32 Abstract: This article compares two one-factor, two two-factor, two three-factor models in the HJM class and Black's [Black, F. (1976). The pricing of commodity contracts. Journal of Financial Economics, 3, 167-179.] implied volatility function in terms of their pricing and hedging performance for Eurodollar futures options across strikes and maturities from 1 Jan 2000 to 31 Dec 2002. We find that three-factor models perform the best for 1-day and 1-week prediction, as well as for 5-day and 20-day hedging. The moneyness bias and the maturity bias appear for all models, but the three-factor models produce lower bias. Three-factor models also outperform other models in hedging, in particular for away-from-the-money and long-dated options. Making Black's volatility a square root or exponential function performs similar to one-factor HJM models in pricing, but not in hedging. Correctly specified and calibrated multifactor models are thus important and cannot be replaced by one-factor models in pricing or hedging interest rate contingent claims. Keywords: Multifactor; HJM; model; Volatility; function; Eurodollar; futures; option (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:revfin:v:18:y:2009:i:1:p:23-32 Access Statistics for this article Review of Financial Economics is currently edited by T. K. Mukherjee and G. Whitney More articles in Review of Financial Economics from Elsevier |
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