An empirical examination of the pricing of European bond options

This paper examines the pricing of European bond options, namely options on a five year Swedish T-bond. A continuous time version of the Ho and Lee model, derived by Heath, Jarrow and Morton, and the Black and Scholes model are tested using Hansen's Generalized Method of Moments. The results indicate that both models perform reasonably well. However, the Black and Scholes model exhibits a ‘time-to-maturity of the bond’ bias, not present in the Heath, Jarrow and Morton model.