Pricing and hedging volatility smile under multifactor interest rate models
 I.Doun Kuo
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The paper extends Amin and Morton (1994), Zeto (2002), and Kuo and Paxson (2006) by considering jumpdiffusion model of Das (1999) with various volatility functions in pricing and hedging Euribor options across strikes and maturities. Adding the jump element into a diffusion model helps capturing volatility smiles in the interest rate options markets, but specifying the meanreversion volatility function improves the most. A humped volatility function with the additional jump component yields better insample and outofsample valuation, but leveldependent volatility becomes more crucial for hedging. The specification of volatility function is more crucial than merely adding jumps into any model and the effect of jumps declines as the maturity of options is longer.
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 Title
 Pricing and hedging volatility smile under multifactor interest rate models
 Journal

Review of Quantitative Finance and Accounting
Volume 36, Issue 1 , pp 83104
 Cover Date
 20110101
 DOI
 10.1007/s1115601001725
 Print ISSN
 0924865X
 Online ISSN
 15737179
 Publisher
 Springer US
 Additional Links
 Topics
 Keywords

 Jumpdiffusion models
 HJM models
 Volatility smile
 Euribor options
 G12
 G13
 Industry Sectors
 Authors

 I.Doun Kuo ^{(1)}
 Author Affiliations

 1. Department of Finance, Tunghai University, 181, TaichungKan Road, Taichung, 407, Taiwan