The Effect of Dynamic Hedging of Options Positions on Intermediate-Maturity Interest Rates
AbstractWhen interest rates change, interest rate options dealers buy or sell securities to adjust the hedging positions that they have taken in order to offset their options exposures. The net result of this trading activity, which is unrelated to economic fundamentals, can be to push interest rates further in the direction they were moving. Such “feedback” effects interfere with the short-term dynamics of interest rate movements and can alter the shape of the yield curve, especially when changes in interest rates are large. Our empirical results confirm the existence of a positive feedback from the activity in the euro-denominated interest rate options market to the european yield curve. This finding can be useful for risk management purposes but also for analysts and policy makers when interpreting short-run movements in the yield curve as signals of future economic activity.
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Bibliographic InfoPaper provided by Bank of Greece in its series Working Papers with number 08.
Length: 32 pages
Date of creation: Dec 2003
Date of revision:
Interest rate options; Dynamic hedging; European yield curve;
Find related papers by JEL classification:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
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