Pricing Eurodollar Futures Options Using the Bdt Term Structure Model: The Effect of Yield Curve Smoothing

Posted: 10 Feb 2001

See all articles by Turan G. Bali

Turan G. Bali

Georgetown University - McDonough School of Business

Ahmet K Karagozoglu

Hofstra University, Zarb School of Business; New York University (NYU) - Volatility and Risk Institute

Abstract

This paper focuses on pricing Eurodollar futures options using the single-factor Black, Derman, and Toy (1990) term structure model with particular emphasis on yield curve smoothing. Of the various approaches, the maximum smoothness forward rate approach developed by Adams and van Deventer (1994), cubic yield spline and linear interpolation are used to produce finely spaced binomial trees. We compare the pricing accuracy associated with the use of yield curve smoothing techniques within the BDT framework. The findings provide the first supporting evidence that using a forward rate curve with maximum smoothness together with a time-varying volatility structure improves best the performance of the BDT model. The empirical results are found to be robust across factors affecting the option price such as time-to-expiration, moneyness, and trading volume.

JEL Classification: G13

Suggested Citation

Bali, Turan G. and Karagozoglu, Ahmet K, Pricing Eurodollar Futures Options Using the Bdt Term Structure Model: The Effect of Yield Curve Smoothing. Available at SSRN: https://ssrn.com/abstract=236386

Turan G. Bali (Contact Author)

Georgetown University - McDonough School of Business ( email )

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Washington, DC 20057
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(202) 687-5388 (Phone)
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HOME PAGE: https://sites.google.com/a/georgetown.edu/turan-bali

Ahmet K Karagozoglu

Hofstra University, Zarb School of Business ( email )

Department of Finance
148 Hofstra University
Hempstead, NY 11549-1480
United States
(516) 463-5701 (Phone)
(718) 701-8331 (Fax)

HOME PAGE: http://sites.hofstra.edu/ahmet-karagozoglu

New York University (NYU) - Volatility and Risk Institute ( email )

44 West 4th Street
New York, NY 10012
United States

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