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Pricing of a European Call Option Under a Local Volatility Interbank Offered Rate Model

Received: 1 February 2018     Accepted: 24 February 2018     Published: 22 March 2018
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Abstract

This research seeks to give insight on how advances in developed money markets can be reflected towards the establishment of derivatives markets in under developed and developing financial markets. The dynamics of the London interbank offered rate, for the developed financial market and the Kenyan interbank offered rate, for the developing financial markets, are compared. For the period between 2013-2015, both interest rates are found to have the same underlying dynamics. A European caplet is priced using the local volatility interbank offered rate model. The local volatility model is used as it captures the volatility smiles more efficiently in one sweep. Thereafter, the local volatility interbank offered rate model is formulated and used to price the European caplet for the developing markets.

Published in American Journal of Theoretical and Applied Statistics (Volume 7, Issue 2)
DOI 10.11648/j.ajtas.20180702.14
Page(s) 80-84
Creative Commons

This is an Open Access article, distributed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution and reproduction in any medium or format, provided the original work is properly cited.

Copyright

Copyright © The Author(s), 2018. Published by Science Publishing Group

Keywords

Call Option, Kenyan IBOR, LIBOR

References
[1] Andersen, L., & Andreasen, J. (2000). Volatility skews and extensions of the libor market model. Applied Mathematical Finance, 7 (1), 1–32.
[2] Berestycki, H., Busca, J., & Florent, I. (2002). Asymptotics and calibration of local volatility models. Quantitative finance, 2 (1), 61–69.
[3] Black, F., & Scholes, M. (1973). The pricing of options and corporate liabilities.
[4] Dupire, B., et al. (1994). Pricing with a smile. Risk, 7 (1), 18–20.
[5] Henry-Labordere, P. (2009). Calibration of local stochastic volatility models to market smiles: A monte-carlo approach. Risk Magazine, September.
[6] Heston, S. L. (1993). A closed-form solution for options with stochastic volatility with applications to bond and currency options. Review of financial studies, 6 (2), 327–343.
[7] Hull, J., & White, A. (1987). The pricing of options on assets with stochastic volatilities. The journal of finance, 42 (2), 281–300.
[8] Jamshidian, F. (1997). Libor and swap market models and measures. Finance and Stochastics, 1 (4), 293–330.
[9] Sepp, A. (2002). Pricing barrier options under local volatility. Math. Comp.
[10] Stein, E. M., & Stein, J. C. (1991). Stock price distributions with stochastic volatility: an analytic approach. Review of financial Studies, 4 (4), 727–752.
[11] Wang, D. L, Huixia Judy “Estimation of high conditional quantiles for heavy-tailed distributions”, 2012.
[12] Zhu, D., & Qu, D. (2016). Libor local volatility model: A new interest rate smile model. Wilmott, 2016 (82), 78–87.
Cite This Article
  • APA Style

    Winnie Mbusiro Chacha, Caroline Njenga, Wilson Mahera. (2018). Pricing of a European Call Option Under a Local Volatility Interbank Offered Rate Model. American Journal of Theoretical and Applied Statistics, 7(2), 80-84. https://doi.org/10.11648/j.ajtas.20180702.14

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    ACS Style

    Winnie Mbusiro Chacha; Caroline Njenga; Wilson Mahera. Pricing of a European Call Option Under a Local Volatility Interbank Offered Rate Model. Am. J. Theor. Appl. Stat. 2018, 7(2), 80-84. doi: 10.11648/j.ajtas.20180702.14

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    AMA Style

    Winnie Mbusiro Chacha, Caroline Njenga, Wilson Mahera. Pricing of a European Call Option Under a Local Volatility Interbank Offered Rate Model. Am J Theor Appl Stat. 2018;7(2):80-84. doi: 10.11648/j.ajtas.20180702.14

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  • @article{10.11648/j.ajtas.20180702.14,
      author = {Winnie Mbusiro Chacha and Caroline Njenga and Wilson Mahera},
      title = {Pricing of a European Call Option Under a Local Volatility Interbank Offered Rate Model},
      journal = {American Journal of Theoretical and Applied Statistics},
      volume = {7},
      number = {2},
      pages = {80-84},
      doi = {10.11648/j.ajtas.20180702.14},
      url = {https://doi.org/10.11648/j.ajtas.20180702.14},
      eprint = {https://article.sciencepublishinggroup.com/pdf/10.11648.j.ajtas.20180702.14},
      abstract = {This research seeks to give insight on how advances in developed money markets can be reflected towards the establishment of derivatives markets in under developed and developing financial markets. The dynamics of the London interbank offered rate, for the developed financial market and the Kenyan interbank offered rate, for the developing financial markets, are compared. For the period between 2013-2015, both interest rates are found to have the same underlying dynamics. A European caplet is priced using the local volatility interbank offered rate model. The local volatility model is used as it captures the volatility smiles more efficiently in one sweep. Thereafter, the local volatility interbank offered rate model is formulated and used to price the European caplet for the developing markets.},
     year = {2018}
    }
    

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    T1  - Pricing of a European Call Option Under a Local Volatility Interbank Offered Rate Model
    AU  - Winnie Mbusiro Chacha
    AU  - Caroline Njenga
    AU  - Wilson Mahera
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    DO  - 10.11648/j.ajtas.20180702.14
    T2  - American Journal of Theoretical and Applied Statistics
    JF  - American Journal of Theoretical and Applied Statistics
    JO  - American Journal of Theoretical and Applied Statistics
    SP  - 80
    EP  - 84
    PB  - Science Publishing Group
    SN  - 2326-9006
    UR  - https://doi.org/10.11648/j.ajtas.20180702.14
    AB  - This research seeks to give insight on how advances in developed money markets can be reflected towards the establishment of derivatives markets in under developed and developing financial markets. The dynamics of the London interbank offered rate, for the developed financial market and the Kenyan interbank offered rate, for the developing financial markets, are compared. For the period between 2013-2015, both interest rates are found to have the same underlying dynamics. A European caplet is priced using the local volatility interbank offered rate model. The local volatility model is used as it captures the volatility smiles more efficiently in one sweep. Thereafter, the local volatility interbank offered rate model is formulated and used to price the European caplet for the developing markets.
    VL  - 7
    IS  - 2
    ER  - 

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Author Information
  • Pan African University, Institute of Basic Sciences, Nairobi, Kenya

  • Pan African University, Institute of Basic Sciences, Nairobi, Kenya

  • Pan African University, Institute of Basic Sciences, Nairobi, Kenya

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