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Do interest rate options contain information about excess returns?

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Author Info

  • Almeida, Caio
  • Graveline, Jeremy J.
  • Joslin, Scott

Abstract

There is strong empirical evidence that long-term interest rates contain a time-varying risk premium. Options may contain valuable information about this risk premium because their prices are sensitive to the underlying interest rates. We use the joint time series of swap rates and interest rate option prices to estimate dynamic term structure models. The risk premiums that we estimate using option prices are better able to predict excess returns for long-term swaps over short-term swaps. Moreover, in contrast to the previous literature, the most successful models for predicting excess returns have risk factors with stochastic volatility. We also show that the stochastic volatility models we estimate using option prices match the failure of the expectations hypothesis.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Econometrics.

Volume (Year): 164 (2011)
Issue (Month): 1 (September)
Pages: 35-44

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Handle: RePEc:eee:econom:v:164:y:2011:i:1:p:35-44

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Web page: http://www.elsevier.com/locate/jeconom

Related research

Keywords: Interest rates Options Risk premia Excess returns Forecasting;

References

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Citations

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Cited by:
  1. Fricke, Christoph, 2012. "Expected and unexpected bond excess returns: Macroeconomic and market microstructure effects," Hannover Economic Papers (HEP) dp-493, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  2. Anders B. Trolle & Eduardo S. Schwartz, 2009. "A General Stochastic Volatility Model for the Pricing of Interest Rate Derivatives," Review of Financial Studies, Society for Financial Studies, vol. 22(5), pages 2007-2057, May.
  3. Gregory R. Duffee, 2012. "Forecasting interest rates," Economics Working Paper Archive 599, The Johns Hopkins University,Department of Economics.
  4. Caio Almeida & Axel Simonsen & José Vicente, 2012. "Forecasting Bond Yields with Segmented Term Structure Models," Working Papers Series 288, Central Bank of Brazil, Research Department.

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