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An Empirical Comparison of Forward‐Rate and Spot‐Rate Models for Valuing Interest‐Rate Options

Author

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  • Wolfgang Bühler
  • Marliese Uhrig‐Homburg
  • Ulrich Walter
  • Thomas Weber

Abstract

Our main goal is to investigate the question of which interest‐rate options valuation models are better suited to support the management of interest‐rate risk. We use the German market to test seven spot‐rate and forward‐rate models with one and two factors for interest‐rate warrants for the period from 1990 to 1993. We identify a one‐factor forward‐rate model and two spot‐rate models with two factors that are not significantly outperformed by any of the other four models. Further rankings are possible if additional criteria are applied.

Suggested Citation

  • Wolfgang Bühler & Marliese Uhrig‐Homburg & Ulrich Walter & Thomas Weber, 1999. "An Empirical Comparison of Forward‐Rate and Spot‐Rate Models for Valuing Interest‐Rate Options," Journal of Finance, American Finance Association, vol. 54(1), pages 269-305, February.
    • Handle: RePEc:bla:jfinan:v:54:y:1999:i:1:p:269-305
    DOI: 10.1111/0022-1082.00104
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    Cited by:

    1. Frank de Jong & Joost Driessen & Antoon Pelsser, 2004. "On the Information in the Interest Rate Term Structure and Option Prices," Review of Derivatives Research, Springer, vol. 7(2), pages 99-127, August.
    2. Driessen, Joost & Klaassen, Pieter & Melenberg, Bertrand, 2003. "The Performance of Multi-Factor Term Structure Models for Pricing and Hedging Caps and Swaptions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(3), pages 635-672, September.
    3. Kabir K. Dutta & David F. Babbel, 2005. "Extracting Probabilistic Information from the Prices of Interest Rate Options: Tests of Distributional Assumptions," The Journal of Business, University of Chicago Press, vol. 78(3), pages 841-870, May.
    4. Frank De Jong & Joost Driessen & Antoon Pelsser, 2001. "Libor Market Models versus Swap Market Models for Pricing Interest Rate Derivatives: An Empirical Analysis," Review of Finance, European Finance Association, vol. 5(3), pages 201-237.
    5. Atkins, Philip J. & Cummins, Mark, 2023. "Improved scalability and risk factor proxying with a two-step principal component analysis for multi-curve modelling," European Journal of Operational Research, Elsevier, vol. 304(3), pages 1331-1348.
    6. Svenstrup, Mikkel, 2003. "On the Suboptimality of Single-Factor Exercise Strategies for Bermudan Swaptions," Finance Working Papers 02-24, University of Aarhus, Aarhus School of Business, Department of Business Studies.
    7. Claudio Henrique Barbedo & Octávio Bessada Lion & Jose Valentim Machado Vicente, 2010. "Pricing Asian Interest Rate Options with a Three-Factor HJM Model," Brazilian Review of Finance, Brazilian Society of Finance, vol. 8(1), pages 9-23.
    8. R.C. Stapleton & Marti G. Subrahmanyam, 1999. "The Term Structure of Interest Rate-Futures Prices," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-045, New York University, Leonard N. Stern School of Business-.
    9. Anna Knezevic, 2024. "Enhancing path-integral approximation for non-linear diffusion with neural network," Papers 2404.08903, arXiv.org.
    10. Joslin, Scott & Konchitchki, Yaniv, 2018. "Interest rate volatility, the yield curve, and the macroeconomy," Journal of Financial Economics, Elsevier, vol. 128(2), pages 344-362.

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