Article ID | Journal | Published Year | Pages | File Type |
---|---|---|---|---|
5090550 | Journal of Banking & Finance | 2009 | 10 Pages |
Abstract
Fixed income options are frequently adopted by companies to hedge interest rate risk. Their payoff dependence on the cumulative short-term rate makes them particularly informative about interest rate volatility risk. Based on a joint dataset of bonds and Asian interest rate options, we study the interrelations between bond and volatility risk premia in a major emerging fixed income market. We propose a dynamic term structure model that generates an incomplete market compatible with a preliminary empirical analysis of the dataset. Approximation formulas for at-the-money Asian option prices avoid the use of computationally intensive Fourier transform methods, allowing for an efficient implementation of the model. The model generates a bond risk premium strongly correlated with a widely accepted emerging market benchmark index (EMBI-Global), and a negative volatility risk premium, consistent with the use of Asian options as insurance in this market.
Related Topics
Social Sciences and Humanities
Economics, Econometrics and Finance
Economics and Econometrics
Authors
Caio Almeida, José Vicente,