Name
Title | ||
|---|---|---|
An Extreme Value Approach to Estimating Interest-Rate Volatility: Pricing Implications for Interest-Rate Options |
Abstract | ||
|---|---|---|
This paper proposes an extreme value approach to estimating interest-rate volatility, and shows that during the extreme movements of the U.S. Treasury market the volatility of interest-rate changes is underestimated by the standard approach that uses the thin-tailed normal distribution. The empirical results indicate that (1) the volatility of maximal and minimal changes in interest rates declines as time-to-maturity rises, yielding a downward-sloping volatility curve for the extremes; (2) the minimal changes are more volatile than the maximal changes for all data sets and for all asymptotic distributions used; (3) the minimal changes in Treasury yields have fatter tails than the maximal changes; and (4) for both the maxima and minima, the extreme changes in short-term rates have thicker tails than the extreme changes in long-term rates. This paper extends the standard option-pricing models with lognormal forward rates to accommodate significant kurtosis observed in the interest-rate data. This paper introduces a closed-form option-pricing model based on the generalized extreme value distribution that successfully removes the well-known pricing bias of the lognormal distribution. |
Year | DOI | Venue |
|---|---|---|
2007 | 10.1287/mnsc.1060.0628 | Management Science |
Keywords | Field | DocType |
interest-rate volatility,interest rates decline,extreme value approach,estimating interest-rate volatility,interest-rate options,pricing implications,extreme change,maximal change,extreme movement,downward-sloping volatility curve,asymptotic distribution,minimal change,generalized extreme value distribution,term structure,extreme value distribution,volatility,extreme value,fat tail,term structure of interest rates,lognormal distribution,forward rates,interest rate,option pricing,normal distribution | Econometrics,Forward rate,Implied volatility,Economics,Generalized extreme value distribution,Yield curve,Extreme value theory,Volatility smile,Forward volatility,Statistics,Volatility (finance) | Journal |
Volume | Issue | ISSN |
53 | 2 | 0025-1909 |
Citations | PageRank | References |
2 | 0.53 | 1 |
Authors | ||
1 | ||
Name | Order | Citations | PageRank |
|---|---|---|---|
| Turan G. Bali | 1 | 19 | 4.86 |