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

Sophie Coutant, Eric Jondeau and Michael Rockinger

No 2010, CEPR Discussion Papers from Centre for Economic Policy Research

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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