Risk Management for Bonds with Embedded Options
This paper examines the behavior of the interest rate risk management measures for bonds with embedded options and studies factors it depends on. The contingent option exercise implies that both the pricing and the risk management of bonds requires modelling future interest rates. We use the Ho and...
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| Format: | Article |
| Language: | English |
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MDPI AG
2020-05-01
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| Series: | Mathematics |
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| Online Access: | https://www.mdpi.com/2227-7390/8/5/790 |
| _version_ | 1797568104208793600 |
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| author | Antonio Díaz Marta Tolentino |
| author_facet | Antonio Díaz Marta Tolentino |
| author_sort | Antonio Díaz |
| collection | DOAJ |
| description | This paper examines the behavior of the interest rate risk management measures for bonds with embedded options and studies factors it depends on. The contingent option exercise implies that both the pricing and the risk management of bonds requires modelling future interest rates. We use the Ho and Lee (HL) and Black, Derman, and Toy (BDT) consistent interest rate models. In addition, specific interest rate measures that consider the contingent cash-flow structure of these coupon-bearing bonds must be computed. In our empirical analysis, we obtained evidence that effective duration and effective convexity depend primarily on the level of the forward interest rate and volatility. In addition, the higher the interest rate change and the lower the volatility, the greater the differences in pricing of these bonds when using the HL or BDT models. |
| first_indexed | 2024-03-10T19:51:37Z |
| format | Article |
| id | doaj.art-7ddb3b31592b401fb006b90a21838c76 |
| institution | Directory Open Access Journal |
| issn | 2227-7390 |
| language | English |
| last_indexed | 2024-03-10T19:51:37Z |
| publishDate | 2020-05-01 |
| publisher | MDPI AG |
| record_format | Article |
| series | Mathematics |
| spelling | doaj.art-7ddb3b31592b401fb006b90a21838c762023-11-20T00:21:34ZengMDPI AGMathematics2227-73902020-05-018579010.3390/math8050790Risk Management for Bonds with Embedded OptionsAntonio Díaz0Marta Tolentino1Department of Economics and Finance, University of Castilla-La Mancha, 02071 Albacete, SpainDepartment of Economics and Finance, University of Castilla-La Mancha, 13003 Ciudad Real, SpainThis paper examines the behavior of the interest rate risk management measures for bonds with embedded options and studies factors it depends on. The contingent option exercise implies that both the pricing and the risk management of bonds requires modelling future interest rates. We use the Ho and Lee (HL) and Black, Derman, and Toy (BDT) consistent interest rate models. In addition, specific interest rate measures that consider the contingent cash-flow structure of these coupon-bearing bonds must be computed. In our empirical analysis, we obtained evidence that effective duration and effective convexity depend primarily on the level of the forward interest rate and volatility. In addition, the higher the interest rate change and the lower the volatility, the greater the differences in pricing of these bonds when using the HL or BDT models.https://www.mdpi.com/2227-7390/8/5/790bonds with embedded optionsnonarbitrage interest rates modelseffective durationeffective convexity |
| spellingShingle | Antonio Díaz Marta Tolentino Risk Management for Bonds with Embedded Options Mathematics bonds with embedded options nonarbitrage interest rates models effective duration effective convexity |
| title | Risk Management for Bonds with Embedded Options |
| title_full | Risk Management for Bonds with Embedded Options |
| title_fullStr | Risk Management for Bonds with Embedded Options |
| title_full_unstemmed | Risk Management for Bonds with Embedded Options |
| title_short | Risk Management for Bonds with Embedded Options |
| title_sort | risk management for bonds with embedded options |
| topic | bonds with embedded options nonarbitrage interest rates models effective duration effective convexity |
| url | https://www.mdpi.com/2227-7390/8/5/790 |
| work_keys_str_mv | AT antoniodiaz riskmanagementforbondswithembeddedoptions AT martatolentino riskmanagementforbondswithembeddedoptions |