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Estimation of the Local Volatility of Discount Bonds Using Market Quotes for Coupon-Bond Options

In: Recent Advances In Financial Engineering

Author

Listed:
  • Hajime Fujiwara

    (Nomura Securities Co., Ltd., Japan)

  • Masaaki Kijima

    (Tokyo Metropolitan University/Kyoto University, Japan)

  • Katsumasa Nishide

    (Yokohama National University, Japan)

Abstract

The key issue to price derivatives written on a coupon bond is the volatility structure, such as volatility smiles and skews, of the corresponding discount bonds, since the coupon bond is a portfolio of discount bonds. This paper proposes a method based on Dupire (1994) to estimate the local volatility of discount bonds when only the prices of coupon-bond options are observed in the market. Numerical examples show that our method can construct the local volatility structure of discount bonds that is consistent with the market data.

Suggested Citation

  • Hajime Fujiwara & Masaaki Kijima & Katsumasa Nishide, 2009. "Estimation of the Local Volatility of Discount Bonds Using Market Quotes for Coupon-Bond Options," World Scientific Book Chapters, in: Masaaki Kijima & Masahiko Egami & Kei-ichi Tanaka & Yukio Muromachi (ed.), Recent Advances In Financial Engineering, chapter 3, pages 49-69, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789814273473_0003
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