Reading Interest Rate and Bond Futures Options' Smiles Around the 1997 French Snap Election

Sophie Coutant, Eric Jondeau and Michael Rockinger (michael.rockinger@unil.ch)

No 2010, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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 react to a political event. We first focus on five dates surrounding the 1997 snap election and several methods: Black (1976), a mixture of log-normals (as in Melik and Thomas (1997)), a Hermite expansion (as in Abken, Madan, and Ramamurtie (1996)), and a method based on Maximum Entropy (following Buchen and Kelly (1996)). The various methods give similar RNDs, yet, by allowing for somewhat dirty options prices, by providing a good fit to options prices, and by being fast, the Hermite expansion approach is the retained method for the data at hand. This approach also allows construction of options with a fixed time until maturity. A daily panel of options running from February 1997 to July 1997 reveals 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. Uncertainty evolved with poll forecasts of who would form the future government.

Keywords: futures option pricing; notional; PIBOR; Political Risk; risk neutral density (search for similar items in EconPapers)
JEL-codes: C52 E43 E52 G13 G14 (search for similar items in EconPapers)
Date: 1998-10
References: Add references at CitEc
Citations: View citations in EconPapers (2)

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