Interest rate caps smile too! But can the LIBOR market models capture the smile?

• 成果类型: Article
• 署名作者: Jarrow, Robert; Li, Haitao; Zhao, Feng
• 署名单位: Cornell University; University of Michigan System; University of Michigan; Rutgers University System; Rutgers University New Brunswick
• 刊物名称: JOURNAL OF FINANCE
• ISSN/ISSBN: 0022-1082
• DOI: 10.1111/j.1540-6261.2007.01209.x
• 发表日期: 2007
• 页码: 345-382
• 关键词: UNSPANNED STOCHASTIC VOLATILITY; term structure; options; bond; jumps

摘要

Using 3 years of interest rate caps price data, we provide a comprehensive documentation of volatility smiles in the caps market. To capture the volatility smiles, we develop a multifactor term structure model with stochastic volatility and jumps that yields a closed-form formula for cap prices. We show that although a three-factor stochastic volatility model can price at-the-money caps well, significant negative jumps in interest rates are needed to capture the smile. The volatility smile contains information that is not available using only at-the-money caps, and this information is important for understanding term structure models.