Pricing Interest Rate Derivatives under Monetary Changes

Alan De Genaro, Marco Avellaneda

Research output: Contribution to journalArticle

Abstract

The goal of this paper is to develop a reduced-form model for pricing derivatives on the overnight rate. The model incorporates jumps around central bank (CB) meetings. More specifically, rate changes are decomposed into fluctuations between CB meetings and deterministic timed jumps following CB meetings. This approach is useful for practitioners, since it allows the extraction of expectations regarding central bank decisions embedded in liquid instruments, as well as the use of these expectations for the pricing of less liquid derivatives, such as options, in a consistent manner. We discuss applications to 30-Day Fed funds options and IDI options traded in Brazil.

Original languageEnglish (US)
JournalInternational Journal of Theoretical and Applied Finance
DOIs
StateAccepted/In press - Jan 1 2018

Fingerprint

Central bank
Interest rate derivatives
Pricing
Jump
Brazil
Derivatives
Derivative pricing
Reduced-form model
Fluctuations

Keywords

  • deterministic timed jumps
  • interest rate derivatives
  • Overnight interest rate

ASJC Scopus subject areas

  • Finance
  • Economics, Econometrics and Finance(all)

Cite this

Pricing Interest Rate Derivatives under Monetary Changes. / De Genaro, Alan; Avellaneda, Marco.

In: International Journal of Theoretical and Applied Finance, 01.01.2018.

Research output: Contribution to journalArticle

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