Reading Interest Rate and Bond Futures Options' Smiles: How PIBOR and National Operators Appreciated the 1997 French Snap Election

S. Coutant, Eric Jondeau and Michael Rockinger ()

Working papers from Banque de France

Abstract: The aim of this paper is to compare various methods which extract a Risk Neutral Density (RND) out of PIBOR as well as of Notional interest rate futures options and to investigate how traders reacted to a political event. We first focus on 5 dates surrounding the 1997 snap election and several methods: Black (1976), a mixture of lognormals (as in Melick and Thomas, 1997), an Hermite expansion (as in Abken, Madan, and Ramamurtie, 1996), and a method based on Maximum Entropy (following Kelly and Buchen, 1996). By and large the various methods give similar RNDs. Yet, the Hermite expansion approach, by allowing for somewhat dirty options prices, by providing a good fit to options prices, and by being very fast is the retained method for the data at hand. We then consider a daily panel of options running from February 1997 to July 1997. After constructing standardized options, i.e. with a fixed time to maturity, we find that operators in both markets anticipated the snap election a few days before the official announcement and that a substantial amount of political uncertainty subsisted even a month after the elections. The greater liquidity of PIBOR options eases information extraction.

Keywords: Interest rate; Pricing; Risk; Politics (search for similar items in EconPapers)
JEL-codes: C52 E43 E52 G13 G14 (search for similar items in EconPapers)
Pages: 28 pages
Date: 1998
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Citations: View citations in EconPapers (4)

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Working Paper: Reading Interest Rate and Bond Futures Options' Smiles: How PIBOR and National Operators Appreciated the 1997 French Snap Election (1998)
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