Hey guys, brushing up on arb. This question threw me for a loop: A callable bond that has not traded recently - you ask both a dealer and a pricing service for a current bid for the bond. The dealer’s bid was 95 and the pricing service provided a bid of 96. Both the dealer and the pricing service are using a binomial model to price the bond based on a spot rate curve calibrated using yesterday’s on-the-run Treasury issues. What is the most likely explanation for how there could be a one percentage point difference between the bids provided by the dealer and the pricing service benchmarked to the same prices of the same Treasury securities?
Could it be different estimates of volatility? The value of the bond with options includes bond’s value plus or minus the value of the option. The value of the option is directly tied to the amount of projected volatility that vary depending on the model used. Maybe there is something else I am not seeing?
I had this exact question. The anwser is vol. - but there are many sub-reasons behind it. I have 2006 books, so idk if page numbers will help. Let me know.