An empirical study of the pricing of reverse floating interest rate‐linked products

Abstract

Purpose

Reverse floating interest rate‐linked structured products are important innovative products for investors to achieve a relatively high yield at low interest rates, and the reasonable pricing of such products is an important factor to influence investors' needs and issuers' profits. The purpose of this paper is to empirically analyze the rationality of the pricing of reverse floating interest rate‐linked products.

Design/methodology/approach

This paper combines the Itô's Lemma and introduces the Black‐Derman‐Toy (BDT) model into the time‐varying volatility to build a binary tree interest rates BDT model under the time‐varying volatility, and to establish the pricing model of reverse floating interest rate‐linked products. Dozens of product data of ABN AMRO Bank and other world‐renowned banks or financial institutions are empirically analyzed.

Findings

The results show that the average pricing of these products is high, and the expected rate of return of the product is lower than the same period of the Five‐year US Treasury Bill rate.

Originality/value

This paper has combined the theory and practice together. The research method described in this paper is of significance to the pricing of interest rate‐linked structured products, and the pricing method of binary tree BDT model to solve the term structure of interest rates and estimation problem of volatility term structure of interest rates.

Citation

Tian, Y., Yang, Q. and Yuan, J. (2013), "An empirical study of the pricing of reverse floating interest rate‐linked products", China Finance Review International, Vol. 3 No. 2, pp. 186-202. https://doi.org/10.1108/20441391311330609