Identifying Volatility Risk Premium from Fixed Income Asian Options
AbstractWe 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 InfoPaper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 136.
Date of creation: May 2007
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Other versions of this item:
- Almeida, Caio & Vicente, José, 2009. "Identifying volatility risk premia from fixed income Asian options," Journal of Banking & Finance, Elsevier, vol. 33(4), pages 652-661, April.
- NEP-ALL-2007-06-02 (All new papers)
- NEP-SEA-2007-06-02 (South East Asia)
- NEP-UPT-2007-06-02 (Utility Models & Prospect Theory)
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