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Identifying Volatility Risk Premium from Fixed Income Asian Options

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  • Caio Ibsen R. Almeida
  • José Valentim M. Vicente

Abstract

We provide approximation formulas for at-the-money asian option prices to extract volatility risk premium from a joint dataset of bonds and option prices. The dynamic model generates stochastic volatility and a time-varying volatility risk premium, which explicitly depends on the average cross section of bond yields and on the time series behavior of option prices. When estimated using a joint dataset of Brazilian local bonds and asian options, the model generates bond risk premium strongly correlated (89%) with a widely accepted emerging markets benchmark index, and a negative volatility risk premium implying that investors might be using options as insurance in this market. Volatility premium explains a significant portion (32.5%) of bond premium, confirming that options are indeed important to identify risk premium in dynamic term structure models.

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Bibliographic Info

Paper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 136.

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Date of creation: May 2007
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Handle: RePEc:bcb:wpaper:136

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  12. Guo, Dajiang, 1998. "The Risk Premium of Volatility Implicit in Currency Options," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(4), pages 498-507, October.
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  16. Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
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Cited by:
  1. Kellard, Neil & Dunis, Christian & Sarantis, Nicholas, 2010. "Foreign exchange, fractional cointegration and the implied-realized volatility relation," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 882-891, April.
  2. José Valentim Machado Vicente & Osmani Teixeira de Carvalho Guillen, 2013. "Do inflation-linked bonds contain information about future inflation?," Revista Brasileira de Economia, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil), vol. 67(2), pages 251-260, June.
  3. Marcos S. Matsumura & José Valentim Vicente, 2009. "The role of macroeconomic variables in sovereign risk," Working Papers Series 196, Central Bank of Brazil, Research Department.
  4. Caio Almeida & José Vicente, 2009. "Are Interest Rate Options Important for the Assessment of Interest Rate Risk?," Working Papers Series 179, Central Bank of Brazil, Research Department.

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