EconPapers    
Economics at your fingertips  
 

On the Information in the Interest Rate Term Structure and Option Prices

Frank de Jong, Joost Driessen () and Antoon Pelsser ()

Review of Derivatives Research, 2004, vol. 7, issue 2, 99-127

Abstract: We examine whether the information in cap and swaption prices is consistent with realized movements of the interest rate term structure. To extract an option-implied interest rate covariance matrix from cap and swaption prices, we use Libor market models as a modelling framework. We propose a flexible parameterization of the interest rate covariance matrix, which cannot be generated by standard low-factor term structure models. The empirical analysis, based on US data from 1995 to 1999, shows that option prices imply an interest rate covariance matrix that is significantly different from the covariance matrix estimated from interest rate data. If one uses the latter covariance matrix to price caps and swaptions, one significantly underprices these options. We discuss and analyze several explanations for our findings.

Date: 2004
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14) Track citations by RSS feed

Downloads: (external link)
http://journals.kluweronline.com/issn/1380-6645/contents (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:revdev:v:7:y:2004:i:2:p:99-127

Ordering information: This journal article can be ordered from
http://www.springer. ... 29/journal/11147/PS2

Access Statistics for this article

Review of Derivatives Research is currently edited by Gurdip Bakshi and Dilip Madan

More articles in Review of Derivatives Research from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().

 
Page updated 2020-11-25
Handle: RePEc:kap:revdev:v:7:y:2004:i:2:p:99-127