Pricing and hedging American fixed-income derivatives with implied volatility structures in the two-factor Heath–Jarrow–Morton model
✍ Scribed by Samuel Yau Man Zeto
- Publisher
- John Wiley and Sons
- Year
- 2002
- Tongue
- English
- Weight
- 408 KB
- Volume
- 22
- Category
- Article
- ISSN
- 0270-7314
No coin nor oath required. For personal study only.
✦ Synopsis
Abstract
Most previous empirical studies using the Heath–Jarrow–Morton model (hereafter referred to
as the HJM model) have focused on the one‐factor model. In contrast, this study implements the Das
(1999) two‐factor Poisson–Gaussian version of the HJM model that
incorporates a jump component as the second‐state variable. This study aims at examining the performance
of the two‐factor model through comparing it with the one‐factor model in pricing and hedging the
Eurodollar futures option. The degree of impact arising from the jump factor also is examined. In addition,
three new volatility specifications are constructed to enhance further the pricing performance of the model.
Their performances are compared according to three performance yardsticks—in‐sample fitting,
out‐of‐sample pricing, and the hedging test. The result indicates that the two‐factor model
outperforms the one‐factor model in both the in‐sample and out‐sample price fitting, but
the one‐factor model performs better in the hedging test. In addition, the HJM model, coupled with the
proposed volatility specification, leads to good fitting results that will be of considerable use to
practitioners and academics in guiding model choice for interest‐rate derivatives. © 2002 Wiley
Periodicals, Inc. Jrl Fut Mark 22:839–875, 2002