dc.contributor.author |
Yu, Jun |
en |
dc.contributor.author |
Phillips, Peter |
en |
dc.date.accessioned |
2006-11-30T20:53:36Z |
en |
dc.date.available |
2006-11-30T20:53:36Z |
en |
dc.date.issued |
2002 |
en |
dc.identifier.citation |
Department of Economics Working Paper Series 242 |
en |
dc.identifier.uri |
http://hdl.handle.net/2292/187 |
en |
dc.description.abstract |
In continuous time specifications, the prices of interest rate derivative securities depend crucially on the mean reversion parameter
of the associated interest rate diffusion equation. This parameter is well known to be subject to estimation bias when standard methods
like maximum likelihood (ML) are used. The estimation bias can be substantial even in very large samples and it translates into a bias
in pricing bond options and other derivative securities that is important in practical work. The present paper proposes a very general
method of bias reduction for pricing bond options that is based on Quenouille's (1956) jackknife. We show how the method can be applied
directly to the options price itself as well as the coefficients in continuous time models. The method is implemented and evaluated here
in the Cox, Ingersoll and Ross (1985) model, although it has much wider applicability. A Monte Carlo study shows that the proposed
procedure achieves substantial bias reductions in pricing bond options with only mild increases in variance that do not compromise the
overall gains in mean squared error. Our findings indicate that bias correction in estimation of the drift can be more important in
pricing bond options than correct specification of the diffusion. Thus, even if ML or approximate ML can be used to estimate more
complicated models, it still appears to be of equal or greater importance to correct for the effects on pricing bond options of bias in
the estimation of the drift. An empirical application to U.S. interest rates highlights the differences between bond and option prices
implied by the jackknife procedure and those implied by the standard approach. These differences are large and suggest that bias
reduction in pricing options is important in practical applications. |
en |
dc.format.extent |
application/pdf |
en |
dc.format.mimetype |
text |
en |
dc.language.iso |
en |
en |
dc.publisher |
ResearchSpace@Auckland |
en |
dc.relation.ispartofseries |
Department of Economics Working Paper Series (1997-2006) |
en |
dc.rights |
Items in ResearchSpace are protected by copyright, with all rights reserved, unless otherwise indicated. Previously published items are made available in accordance with the copyright policy of the publisher. |
en |
dc.rights.uri |
https://researchspace.auckland.ac.nz/docs/uoa-docs/rights.htm |
en |
dc.subject.other |
bias reduction |
en |
dc.subject.other |
Economics |
en |
dc.title |
Jacknifing Bond Option Prices |
en |
dc.type |
Working Paper |
en |
dc.rights.holder |
Copyright: the author |
en |
dc.rights.accessrights |
http://purl.org/eprint/accessRights/OpenAccess |
en |
pubs.org-id |
Economics |
en |