Variance Optimal Cap Pricing Models

J.P. Laurent and Olivier Scaillet
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J.P. Laurent: CREST

No 1999002, LIDAM Discussion Papers IRES from Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES)

Abstract: We propose new closed-form pricing formulas for interest rate options which guarantee perfect compatibility with volatility smiles. These cap pricing formulas are computed under variance optimal measures in the framework of the market model or the Gaussian model and achieve an exact calibration of observed market prices. They are presented in a general setting allowing to study model and numéraire choice effects on the computed prices. Numéraire dependence is particularly emphasized. A numerical example and an empirical application on market data are given to illustrate the practical use of the calibration procedure.

Keywords: Discount bond option; cap pricing formula; volatility smile; variance optimal measure; implied pricing model (search for similar items in EconPapers)
JEL-codes: C4 G13 (search for similar items in EconPapers)
Pages: 41
Date: 1997-12-01, Revised 1999-01-01
New Economics Papers: this item is included in nep-fmk
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Citations: View citations in EconPapers (1)

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Working Paper: Variance Optimal Cap Pricing Models (1999)
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Persistent link: https://EconPapers.repec.org/RePEc:ctl:louvir:1999002

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