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Title: Reading Interest Rate and Bond Futures Options' Smiles Around the 1997 French Snap Election

Author(s): Sophie Coutant, Eric Jondeau and Michael Rockinger

Publication Date: October 1998

Keyword(s): futures option pricing, notional, PIBOR, Political Risk and risk neutral density

Programme Area(s): Financial Economics

Abstract: The aim of this paper is to compare various methods which extract a Risk Neutral Density (RND) out of PIBOR, as well as of Notional interest rate futures options, and to investigate how traders react to a political event. We first focus on five dates surrounding the 1997 snap election and several methods: Black (1976), a mixture of log-normals (as in Melik and Thomas (1997)), a Hermite expansion (as in Abken, Madan, and Ramamurtie (1996)), and a method based on Maximum Entropy (following Buchen and Kelly (1996)). The various methods give similar RNDs, yet, by allowing for somewhat dirty options prices, by providing a good fit to options prices, and by being fast, the Hermite expansion approach is the retained method for the data at hand. This approach also allows construction of options with a fixed time until maturity. A daily panel of options running from February 1997 to July 1997 reveals that operators in both markets anticipated the snap election a few days before the official announcement, and that a substantial amount of political uncertainty subsisted even a month after the elections. Uncertainty evolved with poll forecasts of who would form the future government.

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Bibliographic Reference

Coutant, S, Jondeau, E and Rockinger, M. 1998. 'Reading Interest Rate and Bond Futures Options' Smiles Around the 1997 French Snap Election'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=2010