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Predictive power of the implied volatility term structure in the fixed‐income market

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  • Ren‐Raw Chen
  • Pei‐Lin Hsieh
  • Jeffrey Huang
  • Xiaowei Li

Abstract

We apply the interest rate model of Chen, Hsieh, and Huang (CHH), the CHH model, to explore the implied volatility (IV) term structure's predictive power for bond excess returns. The CHH model has two advantages over existing models: (1) it delivers the IV of the interest rate, rather than the volatility of the swap rate on which the conventional swaption pricing model is built, and (2) the CHH model systematically summarizes 100 swaption prices into a volatility term structure with 10 succinct IVs. By exploiting these advantages, we demonstrate the IV term structure's predictive power and its connection to economic conditions.

Suggested Citation

  • Ren‐Raw Chen & Pei‐Lin Hsieh & Jeffrey Huang & Xiaowei Li, 2023. "Predictive power of the implied volatility term structure in the fixed‐income market," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(3), pages 349-383, March.
    • Handle: RePEc:wly:jfutmk:v:43:y:2023:i:3:p:349-383
    DOI: 10.1002/fut.22386
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