IDEAS home Printed from https://ideas.repec.org/a/fip/fednep/y1998ijunp35-58nv.4no.2.html
   My bibliography  Save this article

Dealers' hedging of interest rate options in the U.S. dollar fixed-income market

Author

Listed:
  • John Kambhu

Abstract

Despite investors' willingness to hold a variety of financial assets and risks, a significant share of interest rate options exposures remains in the hands of dealers. This concentration of risk makes the interest rate options market an ideal place to explore the effects of dealers' dynamic hedging on underlying markets. Using data from a global survey of derivatives dealers and other sources, this article estimates the potential impact of dynamic hedging by interest rate options dealers on the fixed-income market. The author finds that for short-term maturities, turnover volume in the most liquid hedging instruments is more than large enough to absorb dealers' dynamic hedges. For medium-term maturities, however, an unusually large interest rate shock could lead to hedging difficulties.

Suggested Citation

  • John Kambhu, 1998. "Dealers' hedging of interest rate options in the U.S. dollar fixed-income market," Economic Policy Review, Federal Reserve Bank of New York, vol. 4(Jun), pages 35-58.
    • Handle: RePEc:fip:fednep:y:1998:i:jun:p:35-58:n:v.4no.2
    as

    Download full text from publisher

    File URL: https://www.newyorkfed.org/medialibrary/media/research/epr/98v04n2/9806kamb.pdf
    Download Restriction: no
    File URL: https://www.newyorkfed.org/medialibrary/media/research/epr/98v04n2/9806kamb.html
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. De Long, J Bradford, et al, 1990. "Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, vol. 45(2), pages 379-395, June.
    2. Grossman, Sanford J, 1988. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," The Journal of Business, University of Chicago Press, vol. 61(3), pages 275-298, July.
    3. Julia D. Fernald & Frank M. Keane & Patricia C. Mosser, 1994. "Mortgage security hedging and the yield curve," Quarterly Review, Federal Reserve Bank of New York, vol. 19(Sum), pages 92-100.
    4. Bank for International Settlements, 1986. "Recent innovations in international banking (Cross Report)," CGFS Papers, Bank for International Settlements, number 01, december.
    5. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," The Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-151.
    6. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
    7. Lisa N. Galaif, 1993. "Index amortizing rate swaps," Quarterly Review, Federal Reserve Bank of New York, vol. 18(Win), pages 63-70.
    8. Michael J. Fleming, 1997. "The round-the-clock market for U.S. Treasury securities," Economic Policy Review, Federal Reserve Bank of New York, vol. 3(Jul), pages 9-32.
    9. Catherine Benadon & John Kambhu & Frank M. Keane, 1996. "Price risk intermediation in the over-the-counter derivatives markets: interpretation of a global survey," Economic Policy Review, Federal Reserve Bank of New York, vol. 2(Apr), pages 1-15.
    10. Jameson, Mel & Wilhelm, William, 1992. "Market Making in the Options Markets and the Costs of Discrete Hedge Rebalancing," Journal of Finance, American Finance Association, vol. 47(2), pages 765-779, June.
    11. Julia D. Fernald & Frank M. Keane & Patricia C. Mosser, 1994. "Mortgage security hedging and the yield curve," Research Paper 9411, Federal Reserve Bank of New York.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Michael S. Gibson & Matthew Pritsker, 2000. "Improving grid-based methods for estimating value at risk of fixed-income portfolios," Finance and Economics Discussion Series 2000-25, Board of Governors of the Federal Reserve System (U.S.).
    2. Graveline, Jeremy J. & McBrady, Matthew R., 2011. "Who makes on-the-run Treasuries special?," Journal of Financial Intermediation, Elsevier, vol. 20(4), pages 620-632, October.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. John Kambhu, 1997. "Interest rate options dealers' hedging in the US dollar fixed income market," Research Paper 9719, Federal Reserve Bank of New York.
    2. Rüdiger Frey & Alexander Stremme, 1997. "Market Volatility and Feedback Effects from Dynamic Hedging," Mathematical Finance, Wiley Blackwell, vol. 7(4), pages 351-374, October.
    3. David M. Frankel, 2008. "Adaptive Expectations And Stock Market Crashes," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 49(2), pages 595-619, May.
    4. Benjamin H Cohen & Hyun Song Shin, 2002. "Positive feedback trading in the US Treasurey market," BIS Quarterly Review, Bank for International Settlements, June.
    5. Sushant Acharya & Keshav Dogra & Sanjay R. Singh, 2021. "The financial origins of non-fundamental risk," Working Papers 345, University of California, Davis, Department of Economics.
    6. Mingue SUn, 2010. "A Branch-and-Bound Algorithm for Representative Integer Efficient Solutions in Multiple Objective Network Programming Problems," Working Papers 0007, College of Business, University of Texas at San Antonio.
    7. Markus K. Brunnermeier & Lasse Heje Pedersen, 2005. "Predatory Trading," Journal of Finance, American Finance Association, vol. 60(4), pages 1825-1863, August.
    8. Carol L. Osler, 2003. "Currency Orders and Exchange Rate Dynamics: An Explanation for the Predictive Success of Technical Analysis," Journal of Finance, American Finance Association, vol. 58(5), pages 1791-1820, October.
    9. Yiuman Tse & Michael Williams, 2011. "Does Index Speculation Impact Commodity Prices? An Intraday Futures Analysis Using intraday data, we find that unidirectional causality runs from commodity index linked commodity futures to non-index ," Working Papers 0007, College of Business, University of Texas at San Antonio.
    10. Yiuman Tse & Michael R. Williams, 2013. "Does Index Speculation Impact Commodity Prices? An Intraday Analysis," The Financial Review, Eastern Finance Association, vol. 48(3), pages 365-383, August.
    11. John Kambhu & Patricia C. Mosser, 2001. "The effect of interest rate options hedging on term-structure dynamics," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 51-70.
    12. De Bandt, Olivier & Hartmann, Philipp, 2000. "Systemic risk: A survey," Working Paper Series 35, European Central Bank.
    13. Adlai Fisher, 1999. "Multivariate Stock Returns Around Extreme Events: A Reassessment of Economic Fundamentals and the 1987 Market Crash," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-071, New York University, Leonard N. Stern School of Business-.
    14. Fotini Economou & Konstantinos Gavriilidis & Bartosz Gebka & Vasileios Kallinterakis, 2022. "Feedback trading: a review of theory and empirical evidence," Review of Behavioral Finance, Emerald Group Publishing Limited, vol. 15(4), pages 429-476, February.
    15. Adrian, Tobias, 2009. "Inference, arbitrage, and asset price volatility," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 49-64, January.
    16. Qin, Jie, 2015. "A model of regret, investor behavior, and market turbulence," Journal of Economic Theory, Elsevier, vol. 160(C), pages 150-174.
    17. Xue, Yi & Gençay, Ramazan, 2012. "Hierarchical information and the rate of information diffusion," Journal of Economic Dynamics and Control, Elsevier, vol. 36(9), pages 1372-1401.
    18. den Haan, Wouter J. & Sumner, Steven W. & Yamashiro, Guy M., 2007. "Bank loan portfolios and the monetary transmission mechanism," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 904-924, April.
    19. Benjamin M. Friedman, 1995. "Economic Implications of Changing Share Ownership," NBER Working Papers 5141, National Bureau of Economic Research, Inc.
    20. John Kambhu & Til Schuermann & Kevin J. Stiroh, 2007. "Hedge funds, financial intermediation, and systemic risk," Economic Policy Review, Federal Reserve Bank of New York, vol. 13(Dec), pages 1-18.

    More about this item

    Keywords

    Hedging (Finance); options;

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fednep:y:1998:i:jun:p:35-58:n:v.4no.2. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Gabriella Bucciarelli (email available below). General contact details of provider: https://edirc.repec.org/data/frbnyus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.