A pricing kernel approach to valuing options on interest rate futures

Xiaoquan Liu*, Jing-Ming Kuo, Jerry Coakley

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

1 Citation (Scopus)
333 Downloads (Pure)


This paper builds on existing asset pricing models in an intertemporal capital asset pricing model framework to investigate the pricing of options on interest rate futures. It addresses the issues of selecting the preferred pricing kernel model by employing the second Hansen–Jagannathan distance criterion. This criterion restricts the set of admissible models to those with a positive stochastic discount factor that ensures the model is arbitrage-free. The results indicate that the three-term polynomial pricing kernel with three non-wealth-related state variables, namely the real interest rate, maximum Sharpe ratio, and implied volatility, clearly dominates the other candidates. This pricing kernel is always strictly positive and everywhere monotonically decreasing in market returns in conformity with economic theory.

Original languageEnglish
Pages (from-to)93-110
Number of pages18
JournalEuropean Journal of Finance
Issue number2
Early online date15 Apr 2013
Publication statusPublished - 26 Jan 2015


  • LIBOR futures options
  • pricing kernels
  • simulation-based Bayesian approach

ASJC Scopus subject areas

  • Economics, Econometrics and Finance (miscellaneous)


Dive into the research topics of 'A pricing kernel approach to valuing options on interest rate futures'. Together they form a unique fingerprint.

Cite this