Pricing caps with HJM models: the benefits of humped volatility

Jury Falini ()

Department of Economics University of Siena from Department of Economics, University of Siena

Abstract: In this paper we compare different multifactor HJM models with humped volatility structures, to each other and to models with strictly decreasing volatility. All the models are estimated on Euribor and swap rates panel data. We develop the analysis in two steps: first we study the in-sample properties of the estimated models, then we study the pricing performance on caps. We find the humped volatility specification to greatly improve the model estimation and to provide sufficiently accurate cap prices, although the models has been calibrated on interest rates data and not on cap prices. Moreover we find the two factor humped volatility model to outperform the three factor models in pricing caps

Keywords: Finance; interest rates; humped volatility; Kalman filter; cap and floor pricing (search for similar items in EconPapers)
JEL-codes: E43 G12 G13 (search for similar items in EconPapers)
Date: 2009-08
New Economics Papers: this item is included in nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:usi:wpaper:563

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