Pricing Asian Interest Rate Options with a Three-Factor HJM Model

Claudio Barbedo, José Valentim Vicente and Octavio Bessada Lion

No 188, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: Pricing interest rate derivatives is a challenging task that has attracted the attention of many researchers in recent decades. Portfolio and risk managers, policymakers, traders and more generally all market participants are looking for valuable information from derivative instruments. We use a standard procedure to implement the HJM model and to price IDI options. We intend to assess the importance of the principal components of pricing and interest rate hedging derivatives in Brazil, one of the major emerging markets. Our results indicate that the HJM model consistently underprices IDI options traded in the over-the-counter market while it overprices those traded in the exchange studied. We also find a direct relationship between time to maturity and pricing error and a negative relation with moneyness.

Date: 2009-06
New Economics Papers: this item is included in nep-mic, nep-rmg and nep-sea
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Journal Article: Pricing Asian Interest Rate Options with a Three-Factor HJM Model (2010)
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