Identifying Volatility Risk Premia from Fixed Income Asian Options
Author | : Caio Almeida |
Publisher | : |
Total Pages | : 43 |
Release | : 2018 |
ISBN-10 | : OCLC:1304411827 |
ISBN-13 | : |
Rating | : 4/5 ( Downloads) |
Download or read book Identifying Volatility Risk Premia from Fixed Income Asian Options written by Caio Almeida and published by . This book was released on 2018 with total page 43 pages. Available in PDF, EPUB and Kindle. Book excerpt: Fixed income Asian options are frequently adopted by companies to hedge interest rate risk. Having a payoff structure depending on the cumulative short-term rate makes them particularly informativeabout interest rate volatility risk. Based on a joint dataset of bonds and Asian interest rate options, we study the inter-relations between bond and volatility risk premiums in a major emerging fixed income market. We propose and implement 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 bond risk premium strongly correlated (89%) 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. Volatility premium explains a significant portion (33%) of bond premium, indicating that the Asian options market considerably affects the prices of risk of its neighbor bond market.