Advanced Search
MyIDEAS: Login to save this article or follow this journal

The effect of interest rate options hedging on term-structure dynamics

Contents:

Author Info

  • John Kambhu
  • Patricia C. Mosser
Registered author(s):

    Abstract

    Market participants and policymakers closely monitor movements in the yield curve for information about future economic fundamentals. In several recent episodes, however, disruptions to market liquidity have affected the short-term dynamics of the curve independently of fundamentals. This article provides evidence that the short-run dynamics in the intermediate maturities of the yield curve changed around 1990, with the appearance of positive feedback in weekly interest rate changes. The feedback is consistent with the effects of options dealers’ hedging activity and it is found only in the 1990s, after the interest rate options market grew to significant size. The authors also show that the market liquidity/positive-feedback effects are concentrated in the weeks after the largest interest rate changes. Their results suggest that the times when market participants and policymakers are most interested in extracting from the yield curve a signal about economic fundamentals are precisely the times when changes in the curve may be distorted by liquidity effects.

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://www.newyorkfed.org/research/epr/01v07n3/0112kamb.html
    Download Restriction: no

    File URL: http://www.newyorkfed.org/research/epr/01v07n3/0112kamb.pdf
    Download Restriction: no

    Bibliographic Info

    Article provided by Federal Reserve Bank of New York in its journal Economic Policy Review.

    Volume (Year): (2001)
    Issue (Month): Dec ()
    Pages: 51-70

    as in new window
    Handle: RePEc:fip:fednep:y:2001:i:dec:p:51-70:n:v.7no.3

    Contact details of provider:
    Postal: 33 Liberty Street, New York, NY 10045-0001
    Email:
    Web page: http://www.newyorkfed.org/
    More information through EDIRC

    Order Information:
    Email:
    Web: http://www.ny.frb.org/rmaghome/staff_rp/

    Related research

    Keywords: Interest rates ; Options (Finance) ; Hedging (Finance) ; Rate of return ; Liquidity (Economics);

    References

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. Arturo Estrella & Gikas A. Hardouvelis, 1989. "The term structure as a predictor of real economic activity," Research Paper 8907, Federal Reserve Bank of New York.
    2. Laura E. Kodres, 1994. "The existence and impact of destabilizing positive feedback traders: evidence from the S&P 500 Index futures market," Finance and Economics Discussion Series 94-9, Board of Governors of the Federal Reserve System (U.S.).
    3. Stock, J.H. & Watson, M.W., 1989. "New Indexes Of Coincident And Leading Economic Indicators," Papers 178d, Harvard - J.F. Kennedy School of Government.
    4. 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 275-98, July.
    5. Campbell, John, 1995. "Some Lessons from the Yield Curve," Scholarly Articles 3163264, Harvard University Department of Economics.
    6. 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 379-95, June.
    7. Michael J. Fleming, 2000. "The benchmark U.S. Treasury market: recent performance and possible alternatives," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 129-145.
    8. Gerard Gennotte and Hayne Leland., 1989. "Market Liquidity, Hedging and Crashes," Research Program in Finance Working Papers RPF-184, University of California at Berkeley.
    9. Longstaff, Francis A, 2001. "Optimal Portfolio Choice and the Valuation of Illiquid Securities," Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 407-31.
    10. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
    11. Toft, Klaus Bjerre, 1996. "On the Mean-Variance Tradeoff in Option Replication with Transactions Costs," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(02), pages 233-263, June.
    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 in new window

    Cited by:
    1. Robert A. Eisenbeis & W. Scott Frame & Larry D. Wall, 2006. "An analysis of the systemic risks posed by Fannie Mae and Freddie Mac and an evaluation of the policy options for reducing those risks," Working Paper 2006-02, Federal Reserve Bank of Atlanta.
    2. Roberto Perli & Brian Sack, 2003. "Does mortgage hedging amplify movements in long-term interest rates?," Finance and Economics Discussion Series 2003-49, Board of Governors of the Federal Reserve System (U.S.).
    3. 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.

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:fip:fednep:y:2001:i:dec:p:51-70:n:v.7no.3. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Amy Farber).

    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 references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link 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 profile, as there may be some citations waiting for confirmation.

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