Heath, Jarrow and Morton interest rate modelling using principal component analysis
The purpose of this paper is to investigate the performance of three different models in the pricing of call options on ninety-day bank bill futures traded on the Sydney Futures Exchange between 1993 and 2000. The three models analysed are embedded into the Heath, Jarrow, and Morton framework namely; the one, two, and three factor models. Principal Components Analysis was applied in order to provide the forward rate volatility functions necessary to implement several popular multi-factor versions of the Heath, Jarrow, and Morton model. Results showed that the three-factor model consistently outperforms the one and two-factor models. Also the pricing errors are positively correlated with the time to maturity of the option and that no real relationship existed between the errors of one and two-factor models and the date and the moneyness of the options. Although three-factor models exhibited lower errors as time progressed.
Degree Name: Master of Business
Degree Discipline: Finance
Keywords: performance; models; ninety-day bank bill; Sydney Futures Exchange; 1993 and 2000; Heath; Jarrow; and Morton framework; one; two; and three factor; Principal Components Analysis; forward rate volatility; maturity of the option,
Research Type: Thesis