Implied Volatility of Interest Rate Options: An Empirical Investigation of the Market Model |
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Authors: | Charlotte Christiansen Charlotte Strunk Hansen |
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Affiliation: | (1) Department of Finance, The Aarhus School of Business, Denmark;(2) School of Economics and Management, University of Aarhus, Denmark |
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Abstract: | We analyze the empirical properties of the volatilityimplied in options on the 13-week US Treasury bill rate. These options havenot been studied previously. It is shown that a European style put optionon the interest rate is equivalent to a call option on a zero-coupon bond.We apply the LIBOR market model and conduct a battery of validity tests tocompare three different volatility specifications: contact, affine, and exponentialvolatility. It appears that the additional parameter in the affine and theexponential volatility function is not justified. Overall, the LIBOR marketmodel fares well in describing these options. |
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Keywords: | implied volatility interest rate options LIBOR market model market efficiency volatility forecasting zero-couponbond options |
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