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Are Interest Rate Options Important for the Assessment of Interest Rate Risk?

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  • Caio Almeida
  • José Vicente

Abstract

Fixed income options contain substantial information on the price of interest rate volatility risk. In this paper, we ask if those options will provide information related to other moments of the objective distribution of interest rates. Based on a dynamic term structure model, we find that interest rate options are useful for the identification of interest rate quantiles. A three-factor model with stochastic volatility is adopted and its adequacy to estimate Value at Risk of zero coupon bonds is tested. We find significant difference on the quantitative assessment of risk when options are (or not) included in the estimation process of the dynamic model. Statistical back tests indicate that bond estimated risk is clearly more adequate when options are adopted, although not yet completely satisfactory.

Suggested Citation

  • Caio Almeida & José Vicente, 2008. "Are Interest Rate Options Important for the Assessment of Interest Rate Risk?," Working Papers Series 179, Central Bank of Brazil, Research Department.
    • Handle: RePEc:bcb:wpaper:179
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    Cited by:

    1. Wright, Jonathan H. & Zhou, Hao, 2009. "Bond risk premia and realized jump risk," Journal of Banking & Finance, Elsevier, vol. 33(12), pages 2333-2345, December.
    2. Realdon, Marco, 2009. ""Extended Black" term structure models," International Review of Financial Analysis, Elsevier, vol. 18(5), pages 232-238, December.
    3. Fricke, Christoph & Menkhoff, Lukas, 2014. "Financial conditions, macroeconomic factors and (un)expected bond excess returns," Discussion Papers 35/2014, Deutsche Bundesbank.
    4. Azamat Abdymomunov & Filippo Curti, 2020. "Quantifying and Stress Testing Operational Risk with Peer Banks’ Data," Journal of Financial Services Research, Springer;Western Finance Association, vol. 57(3), pages 287-313, June.
    5. Jang, Bong-Gyu & Yoon, Ji Hee, 2010. "Analytic valuation formulas for range notes and an affine term structure model with jump risks," Journal of Banking & Finance, Elsevier, vol. 34(9), pages 2132-2145, September.
    6. Abdymomunov, Azamat & Gerlach, Jeffrey, 2014. "Stress testing interest rate risk exposure," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 287-301.
    7. Allan Jonathan da Silva & Jack Baczynski, 2024. "Exploring non-analytical affine jump-diffusion models for path-dependent interest rate derivatives," Computational Management Science, Springer, vol. 21(1), pages 1-32, June.
    8. João Caldeira & Guilherme Moura & André Santos, 2015. "Measuring Risk in Fixed Income Portfolios using Yield Curve Models," Computational Economics, Springer;Society for Computational Economics, vol. 46(1), pages 65-82, June.
    9. Allan Jonathan da Silva & Jack Baczynski & José Valentim Machado Vicente, 2024. "A Stochastically Correlated Bivariate Square-Root Model," IJFS, MDPI, vol. 12(2), pages 1-24, March.
    10. Fricke, Christoph & Menkhoff, Lukas, 2015. "Financial conditions, macroeconomic factors and disaggregated bond excess returns," Journal of Banking & Finance, Elsevier, vol. 58(C), pages 80-94.

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